The 10% Early Distribution Penalty

While 401k plans and IRAs are designed to be used for retirement savings and the norm is not to touch these funds before reaching retirement age. Circumstances arise where you may need money and thus may have no choice to tap your Solo 401k or IRA earlier. Therefore, you should be aware of these 10 things about the 10% early distribution penalty and 401k plans and IRAs.
  • The 10% penalty applies to IRA distributions taken prior to age 59 ½. If you will be age 59 ½ later in 2016 but you take an IRA distribution today, prior to six months past your 59th birthday, your distribution will be subject to the penalty. This is true even though you will attain age 59 ½ later in the year.
  • The 10% penalty applies only to the taxable portion of your traditional distribution. Any distribution of after-tax dollars (basis) from a traditional IRA would not be subject to the penalty.
  • The 10% penalty usually applies only to the taxable portion of your Roth IRA distribution. However, it also applies to a distribution of converted funds taken within five years from the year of a conversion, unless the funds converted were basis. This is true even though your distribution from the Roth IRA would not be taxable because the taxes would have already been paid on those funds in the year of your Roth IRA conversion.
  • The 10% penalty applies in addition to any income tax you owe on the IRA or solo 401k distribution.
  • Distributions you take from an inherited IRA or Solo 401k plan are never subject to the 10% penalty. This is the case even if both the IRA and solo 401k owner and beneficiary are under age 59 ½.
  • There is an exception to the 10% penalty if you take distributions from your IRA or solo 401k plan as part of a series of substantially equal periodic payments over your life expectancy or the joint life expectancy of you and your beneficiary. These are sometime referred to as 72(t) payments.
  • Your distribution from your IRA or solo 401k plan may not be subject to the 10% penalty if it is taken due to disability, medical expenses, an IRS levy, or taken while you are an active military reservist.
  • Your distribution from your IRA, but not your solo 401k plan, may not be subject to the 10% penalty if is taken to pay for a first home (lifetime cap of $10,000), qualified higher education expenses, or health insurance if you are unemployed.
  • There is no exception to the 10% penalty if you take a distribution from your IRA or solo 401k plan due to economic hardship. There are many court cases where taxpayers have tried making this argument but none have been successful.
  • For IRAs not solo 401k plans, You will use IRS Form 5329 to calculate and pay the 10% penalty when filing your federal income taxes.

SOLO 401(K)

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