Is the 10% Penalty on Early Withdrawal Waiverd For 2022?
Under certain conditions, funds from your IRA and 401(k) accounts can be withdrawn without penalty – such as unreimbursed medical expenses, buying a home, or being separated from service at age 55 or later.
But there are exceptions; money is fungible, and creative thinking may provide ways around paying the 10% penalty.
1. Hardship Distributions
Hardship distributions are subject to both personal income tax rates and an additional 10% early withdrawal penalty for most participants under age 59 1/2. They cannot be transferred back into another plan or IRA, thus depriving participants of future earnings that are compounded over time. Plan sponsors are required to obtain and retain documentation to support hardship withdrawal requests; this includes both principal amount requested as well as tax, fees, or resources available which need substantiating. They can use traditional substantiation methods or accept summaries submitted by participants that satisfy certain requirements provided they meet certain requirements.
Under IRS rules, six financial needs qualify as immediate and heavy financial needs that qualify as immediate and heavy – medical bills, funeral costs, tuition payments for adoption fees or major home repairs. Most advisors advise against raiding retirement accounts to meet emergency expenses; instead recommending low-interest credit cards or alternative financing mechanisms instead. Furthermore, taking a hardship withdrawal could significantly disrupt long-term goals and lead to reduced retirement security.
2. Repayment of Qualified Birth or Adoption Distributions
Under the U.S. Setting Every Community Up for Retirement Enhancement Act (SECURE), passed in 2019, individuals are permitted to withdraw up to $5,000 without incurring an early withdrawal penalty when used to cover qualified birth and adoption expenses. This option is available within both defined contribution plans and IRAs.
Individuals can take a QBAD from any of their qualified accounts–traditional IRAs, Roth IRAs, employer-sponsored retirement plans such as 401(k)s and 403(b) plans–to avoid paying the 10% penalty tax. They can even treat otherwise permissible in-service distributions as QBADs in order to do so.
Law allows individuals to recontribute any qualified birth or adoption distribution they receive within three years into an IRA or qualified plan, in order to reduce tax payments that they might owe as part of receiving this distribution, which could be significant depending on an individual’s tax bracket.
The SECURE Act’s QBAD provision offers people an effective means to meet the expenses associated with birth or adoption, providing some financial relief for struggling families. We strongly suggest anyone considering taking out a QBAD should also look into public assistance programs which cover other significant costs related to raising a family.
3. Repayment of Distributions to Terminally Ill Individuals
Under certain conditions, withdrawing money from a retirement account without incurring the 10% penalty may be possible; however, the IRS still taxes these withdrawals as income.
SECURE 2.0 waives the 10% early withdrawal penalty for distributions from qualified plans, 403(b) plans, SEP IRAs/SIMPLE IRAs/ROTH IRAs made to participants who have been certified by their physician as having terminal illnesses which are expected to result in death within seven years.
TurboTax Tip: Under SECURE 2.0, individuals experiencing economic loss due to federally declared disasters are allowed to withdraw up to $100,000 or, if lesser, their vested retirement plan account balance, without incurring a penalty. They must repay this sum within three years.
Other exceptions may include total and permanent disability, unreimbursed medical expenses exceeding 7.5% of adjusted gross income, and separation from service after age 55 for most public safety employees, or 50 for most.