When one takes a distribution from an IRA or other retirement account, there may be penalty of ten percent of the withdrawn amount. This penalty is in addition to any income tax that may be due on the withdrawal. There are, however, exceptions which will allow a distribution without penalty. Individuals often assume that a distribution may be made without penalty in the event of a hardship situation. This is true, but you must keep in mind that a hardship is defined by the IRS and they probably don’t define hardship the same as you.
There are 14 exceptions that allow you to avoid a penalty, 11 apply to qualified plans including IRA’s. The other three are applicable to IRA’s only.
The first three exceptions are not generally regarded as early distributions.
1.A qualified withdrawal after the account owner attains the age of 59.
2.A withdrawal made after the death of the account owner.
3.A withdrawal made after the permanent disability of the account owner. Note that, to avoid a penalty, the taxpayer must be disabled before the distribution is made.
The next two exceptions relate specifically to employer-sponsored plans.
4.If the employee is age 55 or over, penalty-free distributions may be taken if the employee has separated from service.
5.If the employee receives a series of substantially equal periodic payments for life or jointly with a beneficiary.
The remaining exceptions include some hardship situations, but also some miscellaneous provisions.
6.A distribution made incident to a divorce or to an alternate payee under a Qualified Domestic Relations Order (QDRO). This one gets a little tricky as the rules are very specific. This exception applies if the distribution transfers the interest in the account as a part of the divorce. It must be a trustee-to-trustee transfer or by changing the name on the account if the entire balance is being transferred. The 60-day rollover rules do not apply. This is the only divorce exception to avoiding the penalty.
7.A distribution made to pay IRS levies. I guess the IRS wants to provide as many ways as possible to pay them.
8.A distribution for extraordinary medical expenses. This exception applies only to medical expenses that would be deductible if the taxpayer itemizes deductions. Hence, the withdrawal applies only to medical expenses in excess of the 7.5% (or 10%) AGI threshold.
9.A qualified disaster-relief distribution not in excess of $100,000. It must be within a federally-declared disaster area.
10.Public safety employees separated from service and over age 50 may make penalty-free withdrawals.
11.Reservists called to active duty for at least 179 days are not subject to the penalty.
The three exceptions that relate only to IRAs are as follows.
12.Withdrawals to pay health insurance premiums during a period of unemployment lasting at least 12 consecutive weeks.
13.Withdrawals for qualified for higher than education expenses.
14.Withdrawals to assist a qualified first-time home buyer to purchase a home. You are a first-time home buyer if you or your spouse did not own a home at any time in the previous two years. There is a maximum lifetime withdrawal of $10,000 for this purpose.
Of course, the best advice is to not make any early distributions from your qualified retirement plan. They are designed for retirement, not as rainy-day funds. Any withdrawal will still be subject to income taxes at the regular rates. And don’t forget state taxes. All these taxes and penalties can add up to as much as 50 percent of the withdrawal.
Dr. John Stancil (My Bald CPA) is Professor Emeritus of Accounting and Tax at Florida Southern College in Lakeland, FL. He is a CPA, CMA, and CFM and passed all exams on the first attempt. He holds a DBA from the University of Memphis and the MBA from the University of Georgia. He has maintained a CPA practice since 1979 with an emphasis in taxation. His areas of expertise include church and clergy tax issues and the foreign earned income credit. He prepares all types of returns, individual and business.
Dr. Stancil has written for the Polk County Business Journal and has presented a number of papers at academic conferences. He wrote the Instructor’s Manual for the 13th edition of Horngren’s Cost Accounting. He is published in the Global Sustainability as a Business Imperative, Green Issues and Debates, The Encyclopedia of Business in Today’s World, The Palmetto Business Review, The CPA Journal, and in the NATP TaxPro Journal. His paper, “Building Sustainability into the Tax Code” was recognized as the outstanding accounting paper at the annual meeting of the South East InfORMS. He wrote a book entitled “Tax Issues Faced by U. S. Missionary Personnel Abroad ” that will soon be published.
He has recently launched a new endeavor, Church Tax Solutions, which presents online, on demand seminars on various church and clergy tax issues.
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