Wednesday, November 05, 2008

Exceptions that Avoid Penalties for Early Retirement Plan Distributions

With the current economic decline, it may be likely more people will be taking early withdrawals from retirement accounts. Unfortunately, early withdrawals may be subject to a 10% penalty, in addition to income taxes. Based on the instructions of Form 5329 , there are exceptions that avoid the 10% penalty. Using these exceptions may eliminate the 10% penalty and reduce one's taxes.

Exception Number



Qualified retirement plan distributions (does not apply to IRAs) if you separated from service in or after the year you reach age 55 (age 50 for qualified public service employees).
02Distributions made as a part of a series of substantially equal periodic payments (made at least annually) for your life (or life expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary (if from an employer plan, payments must begin after separation of service).
03Distributions due to total and permanent disability.
04Distributions due to death (does not apply to modified endowment contracts).
05Qualified retirement plan distributions up to (1) the amount you paid for unreimbursed medical expenses during the year minus (2) 7.5% of your adjusted gross income for the year
06Qualified retirement plan distributions made to an alternate payee under a qualified domestic relations order (does not apply to IRAs).
07IRA distributions made to unemployed individuals for health insurance premiums.
08IRA distributions made for higher education expenses.
09IRA distributions made for the purchase of a first home (up to $10,000).
10Distributions due to an IRS levy on the qualified retirement plan.
11Qualified distributions to reservists while serving on active duty for at least 180 days.
12Other (see other on pg. 3 of Form 5329 instructions)

Of note, some exceptions (nos. 7,8, and 9) only apply to IRAs, and some exceptions (nos. 1 and 6) do not apply to IRAs.

It may be helpful to consult a financial or tax advisor before taking an early distribution from a retirement plan. They can help determine of one of the above exceptions apply and, therefore elmiminate the 10% early distribution penalty.

Finally, these are the penalty exceptions that were in effect as of Novbember 5, 2008. There is a possibility that Congress may act to forgive the early distribution penalty in 2008 and provide some economic relief to the tax payer.

For more on The Practice of Personal Finance, check back every Wednesdayf or a new segment.

This is not financial or tax advice. Please consult a professional advisor.

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