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Penalty Exceptions for Early Distributions

When Penalties May Not Be Assessed on Distributions Before Age 59 1/2

Generally, if no exception applies, early distributions from the following plans are subject to a penalty of 10%:

A qualified corporate or Keogh plan
Qualified annuity plan
Tax-sheltered annuity plan
IRA

How the penalty is assessed: The 10% penalty applies to the amount of the early distribution.

For example, if you receive an early distribution of $10,000, the penalty will be $1,000.

Exceptions

No penalty will be assessed on an early distribution if any of the following situations apply to the distribution(s):

Tax-free rollovers of distributions.
Disability distributions due to total disability.
Separation from service if age 55 or older.
Medical costs to the extent you pay deductible medical expenses exceeding 7 1/2% of your adjusted gross income even if you don't itemize your deductions.
Substantially equal payments received for at least five years (at least annually).
Beneficiaries who receive benefits from a deceased plan participant are subject to an early distribution penalty regardless of your age or the age of the participant.
IRS levy. Involuntary distribution that results from an IRS levy on your plan account are not subject to the early distribution penalty.
Distributions paid to an alternate payee pursuant to a qualified domestic relations court order (QDRO) are not subject to early distribution penalty.
Qualified reservist distribution (this a new law).
- If you are a member of the reserves called to active duty before December 31, 2007, for over 179 days, or indefinitely, distributions received during the active duty period that are attributable to elective deferrals (410(k) or 403(b) plan) are not subject to the early distribution penalty.
- A qualified reservist distribution may be recontributed to the plan within two years after the end of the active duty period.
- These rules apply retroactively to individuals called to active duty after September 11, 2001.
- A refund claim may be made on an amended return for a penalty paid on a qualified distribution or for tax paid on a recontributed distribution.
Financial hardship distributions or distributions used for college or home-buying costs:
- 401(k) plans and 403(b) plans:
  - A 10% penalty applies to distributions made before age 59 1/2 if the distribution came from a 401(k) plan or 403(b) tax-sheltered annuity plan even if the money is used to buy a first home, to pay for college, or needed due to financial hardship.
  - There is an exception for a hardship distribution to pay for medical expenses (see above).
- IRA:
  - Early distributions (before age 59 1/2) from an IRS are not subject to the 10% early distribution penalty provided the funds are used to buy a first home, pay for college, or needed due to financial hardship.

Form 1099-R: The payer enters Code 2 in box 7 if your are under age 59 1/2 and the payer knows that you qualify for an exception. Form 1099-R is used to report distributions from pensions, annuities, retirement or profit-sharing plans, IRAs, Insurance contracts, etc.

Need more information? If you're so inclined, and want (or need) more information on IRS penalties, check out the Internal Revenue Manual (IRM), part 20, for more details.

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When Penalties May Not Be Assessed on Distributions Before Age 59 1/2

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