fbpx
What is an Early Withdrawal Penalty?

What is an Early Withdrawal Penalty?

Advertiser Disclosure: Opinions, reviews, analyses, and recommendations are the author's alone, and have not been reviewed, endorsed or approved by any other entity. This site may be compensated through the advertiser affiliate program.

Why would you give the government an extra cut out of your retirement nest egg if you didn’t have to? We all work too hard and save too diligently to just willingly give the Internal Revenue Service a bigger piece of our retirement pie. If you ever end up paying an early withdrawal penalty or early withdrawal fee for taking funds out of your retirement account, you’ve just served up free money to the government.

What is an Early Withdrawal Penalty? 1

Photo by Purpleslog via Flickr

What is an Early Withdrawal Penalty?

All retirement accounts have stipulations about when you can withdraw funds. These stipulations dictate how old the individual must be to begin taking distributions without paying early withdrawal penalties. (They also show when you are forced to begin taking distributions for some type of retirement accounts.)

An early withdrawal penalty is what it sounds like: a fee you pay to the government for withdrawing funds (also called “taking a distribution”) before the allowed retirement age. If you are younger than the retirement age given for the account, you pay an early withdrawal penalty.

Exactly how much of a chunk of your withdrawal the government gets is dependent upon the specific retirement option you are withdrawing funds from.

Which Retirement Accounts Have an Early Withdrawal Penalty?

All retirement accounts have some sort of early withdrawal stipulation, but the details are different. The two key points are: how old you must be to withdraw funds while avoiding paying a penalty, and what the early withdrawal penalty is if you are below that age.

For most retirement accounts the target age you want to be before pulling funds out is 59 and 1/2. And for many retirement options the penalty you will pay if you are under that age is 10% of the withdrawal.

Here’s a short list of popular retirement accounts and the penalties you would pay on early distributions. Remember, the penalty is taken out of the withdrawal, not out of the account. A $1,000 withdrawal with a 10% penalty would net you $900 before you paid taxes on the remaining amount.

Tax Advantaged Accounts

Account Type Minimum Age Penalty
401(k) 59 and 1/2 10%
403(b) 59 and 1/2 10%
Traditional IRA 59 and 1/2 10%

After-Tax Retirement Accounts

Account Type Minimum Age Penalty Note
Roth IRA 59 and 1/2 10% However, note that you can withdraw contributions to your Roth IRA at any time. The early withdrawal penalty only applies to withdrawals of Roth IRA earnings.

Small Business Retirement Accounts

Account Type Minimum Age Penalty Note
SIMPLE IRA 59 and 1/2 10% The early withdrawal penalty is 25% if the distribution is within 2 years of the SIMPLE IRA being established; if it is after the two-year period then the early withdrawal penalty is 10%.
SEP IRA 59 and 1/2 10%
Solo 401(k) 59 and 1/2 10%

How to Avoid Paying Fees for Withdrawing Retirement Funds Early

Not all retirement account distributions are treated the same. If you simply want to withdraw the money to go spend on a vacation or some other unnecessary expense you will end up paying the early withdrawal fee unless you are over the age limit for the account.

However, there are certain instances where early distributions are allowed. These exceptions are account specific, so be sure to read up on your specific retirement account before withdrawing funds.

A few common exceptions include:

  • Hardship distributions – funds needed for medical expenses or after becoming disabled
  • Home ownership – funds used to purchase a home for the first time
  • After death – funds distributed to beneficiaries after the account holder’s death

Remember, You’ll Owe Income Tax, Too (Except for Roth)

Ideally you don’t have a need to touch your retirement account until retirement. Even if you are able to withdraw early and avoid the penalty, remember that you will also have to pay income tax on the distribution if it is a tax-advantaged account. That can easily take 15-33% off the top of whatever amount you’re withdrawing.

It’s even worse if you have to pay the early withdrawal penalty. If you’re in the 28% tax bracket and withdraw $1,000 with an early with a penalty, you’ll lose a ton of money:

  • $1,000 x 10% = $100 penalty, leaves $900
  • $1,000 x 28% tax bracket = $280, leaves $620
  • Total percentage lost to taxes and fees: 38%

You will also miss be forgoing any additional growth in the invested funds. If that $1,000 stayed invested for another 15 years and earned 8% on average, you would end up with almost $3,200.

Recommended Articles

5
Leave a Reply

avatar
5 Comment threads
0 Thread replies
4 Followers
 
Most reacted comment
Hottest comment thread
4 Comment authors
ChesterJonathonSeveri RantanenKaraMoney Infant Recent comment authors
  Subscribe  
newest oldest most voted
Notify of
Money Infant
Guest

It can be very painful to take an early withdrawal from a retirement account which is why I try to ensure that my emergency account is fully funded before putting money into a retirement account. While you can get the retirement money back out, it just isn’t worth it. Like everything in life you have to take the good with the bad. Tax free growth, penalties for accessing too early.

Kara
Guest
Kara

Taking an early withdrawal certainly isn’t worth it. I agree with Money Infant about maintaining an emergency fund. Also, research other retirement planning options that don’t carry the stress of exorbitant fees. Penalties = stress and it shouldn’t/doesn’t have to be that way.

Severi Rantanen
Guest
Severi Rantanen

Of course, what’s ironic about this story is that the current president promised to enable people to take a one-time withdrawal of their IRA without penalty, to deal with the burdens of the economic crisis. So much for campaign promises…

Jonathon
Guest
Jonathon

If I took a Hardship Distribution from 403b, there is no 10% penalty?

It’s just taxed?

Chester
Guest
Chester

Who earns 8%? I’m at .25%.

What is an Early Withdrawal Penalty?

by Kevin Mulligan time to read: 3 min
5