Hertsel Shadian, Attorney at Law, LLC

Tax Effects of an Early Distribution from Your Retirement Plan

25 March 2011

Some taxpayers may have needed to take an early distribution from their retirement plan last year. Individuals who took an early distribution need to be aware that there can be a tax impact to tapping your retirement fund.  Following are some facts about the tax effects of early distributions:

  1. Payments you receive from your Individual Retirement Arrangement (IRA) before you reach age 59½ generally are considered early or premature distributions.
  2. Early distributions usually are subject to an additional 10 percent tax.
  3. Early distributions also must be reported to the IRS as income and are subject to tax at the recipient’s regular income tax rates. However, the tax on this income may be offset by any withholding amounts applied to the distribution. These amounts all should be reported to you on a Form 1099-R issued by the plan administrator.
  4. Distributions you rollover to another IRA or qualified retirement plan (if done correctly) should not be subject to income tax or the additional 10 percent tax. You must complete the rollover within 60 days after the day you received the distribution. Contact your plan administrator for further information.
  5. The amount you rollover generally is taxed when the new plan later makes a distribution to you or your beneficiary.
  6. If you made nondeductible contributions to an IRA and later take early distributions from your IRA, the portion of the distribution attributable to those nondeductible contributions is not taxed.
  7. If you received an early distribution from a Roth IRA, the distribution attributable to your prior contributions should not be taxed.
  8. If you received a distribution from any other qualified retirement plan, generally the entire distribution is taxable unless you made after-tax employee contributions to the plan.
  9. There are several exceptions to the additional 10 percent early distribution tax, such as when the distributions are used for the purchase of a first home, for certain medical or educational expenses, or if you are disabled. Contact your plan administrator to learn more about these exceptions. Note that these exceptions to the 10 percent early distribution tax will not except the distribution from the regular income tax.

For more information about early distributions from retirement plans, the additional 10 percent tax and all the exceptions, contact your professional tax advisor or tax preparer, or see IRS Publication 575, Pension and Annuity Income, and Publication 590, Individual Retirement Arrangements (IRAs). Both publications are available at www.IRS.gov or by calling 800-TAX-FORM (800-829-3676). Also, see IRS Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax Favored Accounts and the Form 5329 Instructions for additional information.  Please also feel free to share this article with others you think that might benefit from this information.