An early distribution from an Individual Retirement
Arrangement (IRA) or a qualified retirement plan need not be a “taxing”
experience. Fortunately, there are exceptions to early distributions.
Any
payment that you receive from your IRA or qualified retirement plan
before you reach age 59½ is normally called an “early” or “premature”
distribution. As such, these funds are subject to an additional 10
percent tax. But there are a number of exceptions to the age 59½ rule
that you should investigate if you make such a withdrawal. Some of these
exceptions apply only to IRAs, some only to qualified retirement plans,
and some to both. IRS Publications 575, Pensions and Annuities, and
590, Individual Retirement Arrangements (IRAs), have details.
In addition to the 10 percent tax on early
distributions, you will add to your regular taxable income any
distributions attributable to “elective deferrals” that you contributed
from your pay, your employer’s contribution and any income earned on all
contributions to the account. If you made any nondeductible
contributions, their portion of the distribution is not taxed, since
you’ve already paid tax on this amount.
There is a
way to avoid paying any tax on early distributions, however. It is
called a “rollover.” Generally, a rollover is a tax-free transfer of
cash or other assets from an IRA or qualified retirement plan to an
eligible retirement plan. An eligible retirement plan is a traditional
IRA, a qualified retirement plan, or a qualified annuity plan. You must
complete the rollover within 60 days of when you received the
distribution. The amount you roll over is generally taxed when the new
plan pays you or your beneficiary.
If the early distribution from an employer’s plan is
paid directly to you, your plan administrator will normally withhold
income tax at a 20 percent rate. If you roll over the distribution to a
new plan, you must replace that 20 percent of the funds that were
withheld and deposit that amount in the new plan or you will owe taxes
on that amount. To avoid the inconvenience of this withholding, you can
have your old plan’s administrator transfer the rollover amount directly
to the new plan or a traditional IRA.
All early
distributions must be reported to the IRS. You will report tax-free
rollovers on lines 15a and 16a of Form 1040 along with any taxable
distributions, but you will enter on line 15b or 16b only the taxable
amounts you don’t roll over.
Early distributions
from retirement plans can involve complex tax issues. Make sure you
understand the issues or get competent tax advice.