What Are the Exceptions to the 10% Early Withdrawal Penalty?

Savers who withdraw funds from individual retirement accounts or workplace plans before age 59 1/2 will typically incur a 10% early withdrawal penalty, in addition to income taxes. But in certain circumstances this penalty may be waived.

As an example, withdrawals made to pay unreimbursed medical expenses do not incur penalties; similar exceptions include buying a first home and taking distributions in substantially equal payments.

1. Qualified education expenses

The IRS maintains an extensive list of qualified education expenses that qualify as tax deductions or credits, with withdrawals from an IRA to cover these costs typically being free from a 10% penalty. These expenses include tuition, fees, textbooks and any other qualified expenses associated with higher education.

Living expenses such as room and board qualify as qualified education expenses if your student is enrolled at least half-time, as do expenses for supplies and equipment needed to take certain courses. Sports-related expenses do not usually qualify.

Not to be forgotten is that any withdrawal amount that is subject to income taxes must still be declared and penalty is applicable on it, so it would be prudent to discuss your college planning strategy with an experienced financial professional before taking action.

2. First-time homebuyer expenses

There are certain expenses exempt from the 10% early withdrawal penalty, including purchasing your first home. Up to $10,000 of your retirement account may be taken out without incurring this fee; however, income tax must still be paid on its distribution.

Other expenses considered exempt expenses include health insurance premiums for yourself or your family if unemployed, distributions to cover qualified education expenses and satisfying an IRS levie. Funeral costs or distributions due to divorce proceedings may also qualify as exempt expenses.

Though it may be tempting to dip into your retirement fund to fund the down payment on a home, before resorting to this tactic you should explore alternatives, such as down-payment assistance programs or accepting gifts from family or friends.

3. Qualified reservist distributions

If you are called into active military duty for at least 179 days, withdrawing elective deferrals and earnings from your retirement plan without incurring the 10% penalty is permitted. Furthermore, this penalty can also be avoided by using distributions to pay qualified education expenses, first-time homebuyer expenses, medical bills or satisfy an IRS tax levy.

Unemployment compensation and permanent disability are two other exceptions to the 10% early withdrawal penalty, allowing you to access funds from an IRA or employer plan without incurring it if either receiving unemployment compensation for at least 12 consecutive weeks, or suffering from severe physical or mental disability which prevents substantial gainful activity – provided documentation supports your claim of severe impairment is presented.

4. Unemployment compensation

Unemployment compensation may exempt distributions taken out of an IRA or 401(k) plan to cover health insurance premiums while receiving unemployment benefits, and withdrawals to cover birth or adoption expenses won’t incur the early withdrawal penalty either.

The Social Security Act grants States considerable leeway when creating unemployment compensation systems within their borders, provided they meet minimum Federal requirements and adopt systems designed to comply with its basic actuarial principles. Each State will make its decision based on employment and unemployment experience alone.

5. Permanent disability

IRS exempts distributions made due to permanent disability from incurring the 10% penalty, per the tax code’s definition of permanent disability as an incapacity to engage in substantial gainful activity due to physical or mental impairment that will continue over an indefinite duration or result in death.

TaxSlayer Pro will automatically transfer any exclusion amounts found within 1099-R to IRS Form 5329 upon exit from this 1099-R menu and claim this exemption from the 10% early withdrawal penalty. To comply with this rule and claim this exception to it, account owners must closely resemble Social Security disability definitions in completing IRS Form 5329 to claim their exception from it. In order to do this, complete IRS Form 5329 reporting how much has been excluded from penalty and provide a doctor’s statement satisfying the stringent requirements set out by code; once exiting 1099-R TaxSlayer Pro will transfer exclusion amount directly onto this Form 5329 form when exiting 1099-R menu TaxSlayer Pro will transfer this exclusion amount directly onto Form 5329 form itself!


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