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What Is the Penalty on Early Withdrawal for Retirement Accounts?

What Is the Penalty on Early Withdrawal for Retirement Accounts?

One of your highest financial priorities should be planning for retirement. There are many resources and incentives designed to help you do this, including specifically designated retirement plans that confer financial advantages to you.
However, you should know that these plans do come with some drawbacks; notably, if you attempt to withdraw money from these accounts before you reach retirement age, you could face a penalty for early withdrawal.
What exactly is this penalty—and how can you avoid it?

The Financial Planning Process

Financial planning is all about managing your financial resources effectively. When it comes to retirement planning, that means maximizing your principal and income while reducing extra fees and expenses.
If you want to make the most of your nest egg and retirement income, you should strive to avoid early withdrawal penalties.

Retirement Accounts and Penalties on Early Withdrawal

In most retirement accounts, such as traditional IRAs, Roth IRAs, and 401(k) plans, you’re only allowed to withdraw money from the account after you reach a certain age.
Currently, that age is 59.5. Once you hit age 59.5, you can start withdrawing money from your retirement accounts freely and with no penalties (though you might owe taxes on your gains, as is the case with a 401(k) plan).
So what happens if you try to withdraw money early? The short answer is that you’ll face a penalty. You’ll owe standard taxes on your income, plus an additional penalty.
The good news is that there are some exceptions to this rule, including for a qualified retirement plan:

  • Redistribution: If you redistribute the funds you took out into a different retirement plan within 60 days, you shouldn’t have to pay an early withdrawal penalty.
  • Disability: If you have a total and permanent disability, you can similarly withdraw funds without penalty.
  • Death of Account Holder: In the event of a death of the account holder, the funds within the account can be redistributed to the beneficiary’s account without penalty.
  • Exceptional Medical Expenses: If you face unreimbursed medical expenses that exceed 10 percent of your total adjusted gross income (AGI), you may withdraw funds from your retirement account without penalty.
  • Dividends From Employee Stock Ownership Plan: If you earn dividends as a result of participation in an employee stock ownership plan, the early withdrawal penalty is waived as well. In addition to these, you can withdraw early from a traditional IRA without penalty for certain types of distributions, including:
  • Health Insurance Premiums: For qualified individuals who are unemployed, you may be able to withdraw without penalty to pay for health insurance premiums.
  • Higher Education Expenses: If you’re withdrawing early to pay for higher education expenses, the withdrawal penalty is waived.
  • A First-Time Home Purchase: If you’re buying your first home, you can also avoid the early withdrawal penalty when pulling out your funds. Additionally, if you have a Roth IRA, you’re free to withdraw money without penalty, up to the amount of your total contributions. For example, let’s say you’ve contributed $30,000 to your Roth IRA and your investments have grown your principal to $45,000. You can safely withdraw up to $30,000 of this money without an early withdrawal penalty.

Need help planning for your financial future? Summit Wealth Partners can help you create a plan.

How To Calculate the Early Withdrawal Penalty

If you withdraw money from a qualified retirement plan before you reach age 59.5, and no exceptions apply to you, you’ll be responsible for paying any federal and state income taxes on your withdrawal. In addition, you’ll pay a 10 percent penalty.

How To Avoid the Early Withdrawal Penalty

How can you avoid the early withdrawal penalty in your retirement accounts?

  • Delay Withdrawal: The most straightforward answer is to delay withdrawal. If you can get by without having to withdraw from your retirement accounts, you’ll be in a much better position.
  • Find an Exception: If you need the money, or if you want to redistribute the money, look for an exception that might apply to you. You can easily circumvent the penalty if you can find one of these loopholes.
  • Seek a Different Type of Plan: A tax-free retirement account (TFRA) could be an even better long-term solution, helping you avoid all early withdrawal penalties—and providing extra advantages at the same time.

Resources for Financial Planning

If you’re interested in more resources for financial planning, be sure to check out our learning center and our blog. Both are packed with educational resources you can use to better understand your risk profile, set goals, and manage your wealth more effectively. Even if you’re an experienced investor, they probably have something new to teach you.
Of course, taking on the burdens of financial planning by yourself can be intimidating—especially if you don’t have much personal experience in this field. That’s why Summit Wealth exists. We help people like you make better financial and investment decisions.

Your Guide Through the Financial Planning Process

If you’re interested in finding out more about our approach to financial planning or if you just need advice on how to manage your money personally, contact us for a free initial consultation today!