Tax Penalty for Early Withdrawal on Profit Sharing Accounts

A profit-sharing arrangement is a qualified plan that allows an employer to contribute tax-deductible money to employee accounts. If the plan is a 401(k), employees can contribute pre-tax compensation to their accounts. You must include the money you withdraw from your profit-sharing account in your taxable income. Early withdrawals are subject to penalties.

Distributions

You can only withdraw profit-sharing money under certain circumstances. You will receive a distribution if your employer ends the plan without creating a replacement. You can take your money once you reach age 59 1/2 or if you suffer a qualified financial hardship. Reservists can withdraw their profit-sharing money if they are called to active duty lasting at least 180 days. If you die, your beneficiaries or estate receives the account assets. You can also grab your money if you leave your job or become disabled.

Early Withdrawals

If you withdraw money from your profit-sharing account before age 59 1/2, the Internal Revenue Service will slap on a 10 percent penalty unless you roll the money into an individual retirement account or another employer plan. You can also avoid the penalty if you qualify for an exception, including disability, leave the job after reaching age 55, are a reservist called to active duty or need to pay taxes you owe. In addition, the IRS exempts early withdrawals resulting from medical costs, divorce settlements, excess contributions and the employee’s death.

Substantially Equal Periodic Payments

If you’re younger than 55 when you leave your job, you can withdraw your profit-sharing money without triggering a penalty by taking a series of substantially equal periodic payments. Your annual distributions are based on your life expectancy, optionally combined with the life expectancy of your beneficiary. You must continue to take the payments for five years or until you reach age 59 1/2, whichever occurs later. However, death or disability removes the need to continue taking payments.

Other Penalties

Your profit-sharing account is subject to penalties for reasons other than early withdrawal. These penalties apply to prohibited transactions made by the employee and other “disqualified persons,” including relatives, the employer and people who have some control over the account. You are prohibited from transferring, selling or lending account assets to a disqualified person. Certain other transactions are taboo. The penalty for these transgressions is 15 percent of the amount involved, but failing to remedy the problem can boost the penalty to 100 percent.

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About the Author

Based in Chicago, Eric Bank has been writing business-related articles since 1985, and science articles since 2010. His articles have appeared in "PC Magazine" and on numerous websites. He holds a B.S. in biology and an M.B.A. from New York University. He also holds an M.S. in finance from DePaul University.

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