People may need to tap into their individual retirement account before turning age fifty-nine and a half. That’s the age before a distribution from an individual retirement account is considered “early.” Early distributions are potentially subject to an additional 10% tax. That’s ten percent on top of the regular tax rates that would apply.
Here’s some tips for people thinking about taking an early distribution from their individual retirement account:
Exceptions to the 10% Early Distribution Surtax
- You had a “direct rollover” to your new retirement account.
If your retirement savings is rolled over directly from your old retirement account to a new retirement account in a trustee-to-trustee transfer, that rollover does not count as a distribution. This is a non-taxable event and the 10% surtax does not apply.
- You received a lump-sum payment but rolled over the money to a qualified retirement account within 60 days.
If you indirectly rollover savings from your old retirement account by taking possession of the funds yourself personally, and then re-depositing that money into another retirement account, this indirect rollover does not count as a distribution.
This is a non-taxable event and the 10% surtax does not apply. Be aware that a person has 60 days to complete an indirect rollover. And the administrator of the old retirement plan will likely withhold taxes, which means you’ll receive less than the gross amount. If you want to roll over the entire gross amount (so as to avoid taxes and surtaxes), you’ll need to use other funds to make up the difference.
For example, you have $10,000 in IRA1 and want to do an indirect rollover to IRA2. The plan administrator withholds 20% federal tax ($2,000) and cuts you a check for $8,000. If you rollover only the $8,000 amount within the 60-day time frame, you will avoid tax and the 10% surtax on that $8,000, but the remaining $2,000 would be taxable. In order to avoid taxes on the full amount of $10,000 amount, you will need to use other funds to make up the difference. (You’ll get the $2,000 withheld back as as a credit for prepaid tax when you file your tax return.)
- You were permanently or totally disabled.
The 10% surtax does not apply if a person is disabled. “You are considered disabled,” the IRS says, “if you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long, continued, and indefinite duration” (Publication 590-B, Distributions from Individual Retirement Arrangements, section on disabled).
- You were unemployed and paid for health insurance premiums.
There are four criteria to qualify for the health insurance exception to the 10% surtax.
- You lost your job.
- You received unemployment compensation for at least 12 consecutive weeks.
- You distributed money from your IRA either in the same year as you received the unemployment compensation or in the following year.
- You distributed money from your IRA no later than 60 days after becoming re-employed.
If all these four conditions are met, then the 10% surtax does not apply on the amount of the early distributions, up to the full amount of cost of health insurance for yourself and your family during the year. (Publication 590-B, section on medical insurance.)
- You paid for college expenses for yourself or a dependent.
Early distributions up to the amount of qualified higher education expenses is not subject to the 10% surtax. Higher education expenses include the cost of tuition, books and other necessary supplies and equipment for postsecondary education such as colleges, universities, and trade schools.
(Publication 590-B, section on higher education expenses.)
- You bought a house for the first time.
First-time homebuyers can take an early distribution of up to $10,000 from their IRA without having to pay the 10% surtax. There are three criteria to qualify:
- The amount distributed from the IRA is used to pay costs related to buying, building, or rebuilding a home, or any closing costs.
- A first-time homebuyer is someone who has not owned a primary residence in the two year period ending on the date of purchase. (Parents or grand-parents can also use the first-time homebuyer exception to help their kids or grandkids buy a house.)
- There’s a lifetime limit of $10,000 for all first-time homebuyer distributions per person.
If married, both spouses can take $10,000 from their IRAs without the 10% surtax.
- You paid for medical expenses exceeding 10% of your adjusted gross income.
Persons with significant unreimbursed medical expenses can take an early distribution without paying the 10% surtax. The 10% surtax does not apply to the amount of early distributions that are not more than the amount paid out-of-pocket for medical expenses during the year minus 10% of your adjusted gross income. Note: taxable distributions will increase adjusted gross income.
- The IRS levied your retirement account to pay off tax debts.
If the Internal Revenue Service levies your IRA to pay outstanding tax debts, that distribution is not subject to the 10% surtax. The IRS is aware of this exception.
- You are called to active duty as a reservist.
People serving in the Army National Guard, Army Reserve, Naval Reserve, Marine Corps Reserve, Air National Guard, Air Force Reserve, Coast Guard Reserve or Reserve Corps of the Public Health Service can take early distributions from their IRAs without the 10% surtax if the following four conditions are met:
- The person is called to active duty after September 11, 2011.
- The person is called to active duty for more than 179 days or for an indefinite period of time as a member of a reserve component.
- The early distribution comes from an IRA or from the elective deferrals component of a 401(k) or 403(b) or similar group plan.
- The early distribution occurs between the date of the order or call to active duty and the close of the active duty period. (In other words, the distribution does not occur before or after that time frame.)