Early Retirement Distributions by Carolyn Flaherty

During difficult economic times such as those we have been experiencing in recent years, it is not uncommon for people to obtain funds by borrowing from or cashing out their retirement accounts. Based on your personal financial circumstances, there may be no choice in the matter of tapping into these assets. However, there are tax consequences in addition to the obvious dilemma of diminishing savings for your future.

The facts:

• Distributions from a retirement account are taxable
• Any payments from a retirement account before you have reached age 59 and 1/2 are considered early or premature distributions and therefore are subject to an additional 10% tax
• Early distributions are required to be reported to the IRS
• Unless specifically instructed, distributions will not necessarily withhold for expected state and federal taxes. This can result in an unexpectedly large tax bill with potential for interest and penalty on April 15th. If you are withdrawing due to economic difficulty this will be an especially unpleasant outcome.

Is any portion of the distribution non-taxable?

• Non-deductible contributions to a retirement plan are not taxable to you upon distribution (we thank the government for not double dipping)
• Distributions that are rolled into another qualified plan within 60 days are not taxed. Note therefore, that if your need for cash is brief and you know with absolute certainty that you can replenish the cash into another plan within 60 days: an early distribution may provide a means to obtain temporary funds.
• The portion of an early distribution from a ROTH IRA that represents your contributions is not taxable, (again: no double dipping even if you are executing an early withdrawal).

The exceptions:

The government allows for certain specific exceptions to the application of the 10% additional tax BUT NOT to the income tax. The exceptions are listed below.

• Purchase of a first home
• Certain medical expenses
• Certain educational expenses
• Your disability
• Distributions after you reach age 59 1/2

Note that on the flip-side, upon reaching the age of 70 and 1/2, you MUST take minimum mandatory withdrawals from your individual retirement accounts. The first must be taken by April 1 of the year after you turn 70 and 1/2 and again in December of the same year. Your minimum withdrawal is determined by a formula based on your account values and life expectancy. The financial service firms that manage your retirement accounts will report the minimum distribution amount to you and to the IRS every year. Your minimum distribution changes every year. Failure to take the minimum distribution will result in a tax penalty of 50% of the amount that you did not withdraw.

For additional information on retirement distribution issues: visit IRS.gov to find IRS Publication 575, Pension and Annuity Income, and IRS Publication 590, Individual Retirement Arrangements, or contact your tax advisor.