Avoiding Premature Distribution Penalties
A 10% premature distribution penalty normally applies to distributions taken before age 59½ from an IRA or employer sponsored retirement account (other than a §457). However, §72(t) distributions (named after the tax code that governs them) are exempt from this penalty.
To qualify for penalty-free distributions under one of the §72(t) provisions, traditional and Roth
§403(b)/§401(k) participants must attain age 55 or more in the year they retire. If the accountholder retires at a younger age, he or she must wait until age 59½ to be free from §72(t) restrictions. This age exemption does not apply to IRA/Roth IRA accountholders.
Under §72(t), the premature distribution penalty can be waived for distributions that are part of a series of substantially equal periodic payments based on the life expectancy of the participant or the joint life expectancy of the participant and a designated beneficiary (distributions will still be subject to ordinary income taxes). Participants in a §403(b)/§401(k) or other qualified plan are eligible only after separation from service, while IRA/Roth IRA owners may benefit at any time.
Once a stream of §72(t) distributions has begun, it must continue for five years or until attainment of age 59½, whichever is longer. Any variation from the established payment schedule will result in the 10% penalty, applied retroactively. Withdrawal amounts may be stopped or changed once the mandatory distribution period passes.
Roth IRAs
With Roth IRA accounts, if distributions are taken prior to your eligibility for tax-free withdrawals, contributions are distributed first, then conversions, and finally earnings. Conversions will be penalized if the monies have not been in the account for more than five years. Earnings will be penalized unless an exception to the premature penalty exists.
Roth §403(b) / Roth §401(k)
With Roth §403(b)/§401(k) accounts, if distributions are taken prior to your eligibility for tax-free withdrawals, they will be partially return of principal and partially taxable earnings. Earnings will be penalized unless an exception to the premature penalty exists.
Your Legend Advisor can explain your distribution options and help you avoid paying unnecessary penalties.
Legend Equities Corporation and its affiliates do not provide tax information or advice.