The 10% Early Withdrawal Tax, and the Exceptions That Apply

Money in a 401(k) or IRA is meant for retirement, and the tax code nudges you to leave it there. If you take a distribution before age 59 and a half, you generally owe a 10% additional tax on top of regular income tax on the taxable amount. But the IRS lists a long set of exceptions, and the details matter: some apply only to IRAs, others only to workplace plans like a 401(k).

What the 10% applies to

The IRS explains that the 10% additional tax generally applies to early distributions from qualified plans, 403(a) and 403(b) annuity plans, and traditional IRAs, including IRAs connected to a SIMPLE IRA or SEP plan. Qualified plans include 401(k) plans, traditional pensions, cash balance plans, and profit-sharing plans.

Two special cases from the IRS:

• SIMPLE IRA: distributions made within the first 2 years of participation incur a 25% additional tax instead of 10%.
• Governmental 457(b): distributions are not subject to the 10% additional tax, except amounts attributable to rollovers from another type of plan or IRA.

Distributions with an exception are reported using Form 5329 when needed.

What it costs without an exception

Suppose someone age 45 withdraws $8,000 from a traditional IRA with no exception. The additional tax is 10% x $8,000 = $800, and the $8,000 is also generally included in taxable income for the year. The total cost depends on the person's tax bracket, but the $800 is on top of it.

Exceptions that apply to both IRAs and workplace plans

According to the IRS table, the following exceptions apply to both:

• reaching age 59 and a half
• death or total and permanent disability of the account owner
• a series of substantially equal periodic payments
• unreimbursed medical expenses above 7.5% of adjusted gross income
• up to $5,000 per child for qualified birth or adoption expenses
• one distribution per calendar year for personal or family emergency expenses, up to the lesser of $1,000 or the vested balance over $1,000
• up to $22,000 for qualified individuals with economic loss from a federally declared disaster where they live
• for domestic abuse victims, up to the lesser of $10,000 or 50% of the account
• an IRS levy on the plan, and certain distributions to qualified military reservists called to active duty

Exceptions that apply only to IRAs

These do not apply to a 401(k) or similar workplace plan:

• qualified higher education expenses
• qualified first-time homebuyers, up to $10,000
• health insurance premiums paid while unemployed

This is a common trap. Someone who withdraws from a 401(k) for college costs or a first home does not get these exceptions; the same withdrawal from an IRA might qualify.

Exceptions that apply only to workplace plans

These do not apply to IRAs:

• separating from service during or after the year you reach age 55 (age 50 for certain public safety employees)
• distributions to an alternate payee under a qualified domestic relations order
• distributions to a terminally ill employee certified by a physician (marked as applying to qualified plans in the IRS table)
• corrective distributions of excess contributions and deferrals, and dividend pass-throughs from an ESOP

The age 55 rule is worth special attention. If you leave a job in or after the year you turn 55, distributions from that employer's plan can avoid the 10% tax. If you first roll the money into an IRA, that exception no longer applies to it.

Rollovers are not distributions for this purpose

The IRS lists rollovers as an exception: amounts contributed to another retirement plan or IRA within 60 days, and in-plan Roth rollovers, are not subject to the 10% additional tax.

Before taking an early withdrawal

1. Confirm whether the account is an IRA or a workplace plan, since the exception lists differ.
2. Check whether an exception applies, and keep documentation supporting it.
3. Estimate both the 10% additional tax and the regular income tax.
4. Consider whether another source of money would cost less overall.

Key takeaways

• Distributions before age 59 and a half generally carry a 10% additional tax plus regular income tax.
• A SIMPLE IRA distribution within the first 2 years of participation carries 25% instead of 10%.
• Education, first-home (up to $10,000), and unemployed health insurance exceptions apply only to IRAs.
• The age 55 separation-from-service exception applies only to workplace plans, not IRAs.
• Newer exceptions include $1,000 for emergencies once per year and up to $5,000 per child for birth or adoption.