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Early Distributions From Retirement Plans
By: Richard Chapo
An early distribution from an Individual Retirement Arrangement (IRA) or a
qualified retirement plan need not be a “taxing” experience. Fortunately, there
are exceptions to early distributions.
Any payment that you receive from your IRA or qualified retirement plan before
you reach age 59½ is normally called an “early” or “premature” distribution. As
such, these funds are subject to an additional 10 percent tax. But there are a
number of exceptions to the age 59½ rule that you should investigate if you make
such a withdrawal. Some of these exceptions apply only to IRAs, some only to
qualified retirement plans, and some to both. IRS Publications 575, Pensions and
Annuities, and 590, Individual Retirement Arrangements (IRAs), have details.
In addition to the 10 percent tax on early distributions, you will add to your
regular taxable income any distributions attributable to “elective deferrals”
that you contributed from your pay, your employer’s contribution and any income
earned on all contributions to the account. If you made any nondeductible
contributions, their portion of the distribution is not taxed, since you’ve
already paid tax on this amount.
There is a way to avoid paying any tax on early distributions, however. It is
called a “rollover.” Generally, a rollover is a tax-free transfer of cash or
other assets from an IRA or qualified retirement plan to an eligible retirement
plan. An eligible retirement plan is a traditional IRA, a qualified retirement
plan, or a qualified annuity plan. You must complete the rollover within 60 days
of when you received the distribution. The amount you roll over is generally
taxed when the new plan pays you or your beneficiary.
If the early distribution from an employer’s plan is paid directly to you, your
plan administrator will normally withhold income tax at a 20 percent rate. If
you roll over the distribution to a new plan, you must replace that 20 percent
of the funds that were withheld and deposit that amount in the new plan or you
will owe taxes on that amount. To avoid the inconvenience of this withholding,
you can have your old plan’s administrator transfer the rollover amount directly
to the new plan or a traditional IRA.
All early distributions must be reported to the IRS. You will report tax-free
rollovers on lines 15a and 16a of Form 1040 along with any taxable
distributions, but you will enter on line 15b or 16b only the taxable amounts
you don’t roll over.
Early distributions from retirement plans can involve complex tax issues. Make
sure you understand the issues or get competent tax advice.
About the Author:
Richard Chapo is CEO of http://www.businesstaxrecovery.com - Obtaining tax
refunds for small businesses for overpaid taxes. Discovery tax strategies and
deductions in our tax articles section.
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