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Tax Issues with early Distributions from Retirement savings.

Taxpayers may sometimes find themselves in situations when they need to withdraw money from their retirement plan early. What they may not realize is that that it may mean a tax impact when they file their return.

To discourage the use of IRAs for the purposes other than retirement, tax law imposes a 10% additional tax on early distributions from traditional and Roth IRAs unless an exception applies. Generally, early distributions are those you receive from an IRA before reaching age 59 1/2. The 10% additional tax applies to the part of the distribution that you have to include in gross income. It is in addition to any regular income tax on the early distribution amount.

Here are a few facts you should know about the tax implications of an early distribution from your retirement plan.

  • Payments you receive from your Individual Retirement Arrangement before you reach age 59 1/2 are generally considered early or premature distributions.
  • Early distributions are usually subject to an additional 10% tax.
  • Early distributions must be reported to the IRS.
  • Distributions you roll over to another IRA or qualified retirement plan are not subject to the additional 10% tax. You must complete the rollover within 60 days after the day you received the distribution.
  • The amount you roll over is generally taxed when the new plan makes a distribution to you or your beneficiary.
  • If you made nondeductible contributions to an IRA and later take early distributions from your IRA, the portion of the distribution attributable to those nondeductible contributions is not taxed.
  •  If you received an early distribution from a Roth IRA, the distribution attributable to your prior contributions is not taxed.
  • If you received a distribution from any other qualified retirement plan, generally the entire distribution is taxable unless you made after-tax employee contributions to the plan.
  • There are several exceptions to the additional 10 percent early distribution tax, such as when the distributions are used for the purchase of a first home (up to $10,000), for certain medical or educational expenses, or if you are totally and permanently disabled.

For more information about the tax related impacts of early distributions from retirement plans, please visit my web page Improving Your Retirement.

© 2013, Bruce McFarland. All rights reserved.

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