Retirement accounts that provide tax breaks have very specific rules that must be followed if you want to enjoy the financial rewards of those tax breaks.
One of these rules defines WHEN you’re allowed to pull money from your retirement accounts. If you pull money too soon, you’re at risk of being levied with a penalty by the IRS. There are several exceptions to this rule, such as paying for qualified higher education expenses or paying for expenses if you become permanently disabled. In general, though, if you withdraw retirement funds before you reach age 59½, you’ll be hit with a 10% penalty in addition to regular income taxes. In the April 2023 court case Magdy A. Ghaly and Laila Ryad v. Commissioner, the taxpayers learned this rule the hard way.
The Facts
In 2018, Mr. Ghaly took two distributions from his retirement account.
Distribution #1: Withdrawal
Mr. Ghaly was laid off from his job, and in 2018, he withdrew money from his retirement account to provide for his family. He requested and received a withdrawal of $71,147 from his retirement account. His retirement company provided him with a Form 1099-R indicating the withdrawal was taxable.
Distribution #2: Deemed Distribution
In 2015, Mr. Ghaly took a loan from his retirement account. Because the loan followed certain IRS-approved guidelines, it was not considered a taxable distribution from his account that year. However, when Mr. Ghaly failed to repay that loan when it came due in 2018, it became a taxable distribution. His retirement company provided him with a 1099-R tax form for the deemed distribution.
Mr. Ghaly had not yet reached age 59½ before either amount was distributed.
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