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.
