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Avoiding 401(k) and IRA Early Distribution Penalties

3 min read


3 min read


You save up for retirement in an IRA or 401(k) plan, only to realize that you need the money sooner than planned. Or maybe you change jobs and need to move your retirement money over to a new account. If these situations occur, what early distribution penalty exceptions can you take advantage of? Don’t worry — we’re here to help explain what you can do. 

Exceptions to Early Distribution Penalties

You usually put money into a tax-deferred savings plan to save for your future retirement. If you withdraw money from your plan before age 59 1/2, you might have a 10% early withdrawal penalty. However, there are exceptions to this early distribution penalty.

The penalty doesn’t usually apply to distributions from your employer plan or IRA if any of these are true:

  • You’re totally and permanently disabled.
  • Your beneficiary receives the distribution from your retirement plan after your death.
  • You receive distributions as a series of mostly equal periodic payments based upon either:
    • Your life expectancy
    • The joint life expectancies of you and your beneficiary

IRAs have additional exceptions to the 10% early distribution penalty. You won’t have a penalty for a distribution from your IRA if you use it:

  • To pay for health insurance premiums. Both of these must be true:
    • You’re unemployed.
    • You’ve received unemployment compensation for at least 12 consecutive weeks.
  • To pay for higher education expenses.
  • To buy, build, or rebuild a home for certain people. These people must not have had an ownership interest in a main home for at least two years. If this is true, you can use your IRA distribution for any of these people:
    • Yourself
    • Spouse
    • Child
    • Grandchild
    • Parent, grandparent, great-grandparent, etc.

Additional exceptions to the 10% early distribution penalty apply to 401(k) plans. See IRS Publication 575 for more information. 

Even if you don’t pay a penalty, the taxable part of the distribution will be taxed as ordinary income.

Rollover Your Employer-Sponsored Retirement Plan Account

When you change jobs, you might consider rolling over your company retirement account assets into an IRA or to a new employer’s plan. You can complete a retirement rollover in two ways: a direct rollover or an indirect rollover. You could incur an early withdrawal penalty of 10% for an indirect rollover. Read on to understand why. 

With a direct rollover, the plan administrator will send the retirement rollover distribution directly to either the your IRA account or your new employer’s plan. In this case, you’re keeping the money invested, so an early withdrawal penalty doesn’t apply. 

With an indirect rollover, the funds are sent to you and not the final account. There’s one big difference here. The money you’ll receive will be the distribution amount minus a government withholding. 

When depositing your retirement rollover funds in the new IRA or plan, you’ll need to make up the amount that was withheld to fully fund the rollover. If you don’t fully fund the retirement rollover within 60 days, you’ll pay a penalty because it will count as an early distribution. 

Special Cases

Rolling over your retirement plan distribution into an IRA stops you from using certain rules. Ex: You won’t be able to use the special ten-year averaging rules if you:

  • Were born before Jan. 2, 1936
  • Are a beneficiary of a plan participant born before Jan. 2, 1936

If you don’t want tax withheld from a retirement plan distribution that isn’t a retirement rollover, you must complete Form W-4P. If you don’t withhold tax, you might have to make estimated payments for your tax liability. Tax isn’t usually withheld if you expect the distribution won’t be in your gross income.

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