If you want to take an early payout from a retirement plan, you might face extra fees and tax penalties. Your exposure to these costs depends on a number of circumstances, including your age, the type of annuity plan and your eligibility for a penalty exception. Knowing your options might help you reduce the costs of an early payout.
A retirement plan annuity might be qualified or nonqualified depending on the type of employer plan. In either case, a single-life annuity contract matures on the annuity date, when the owner must decide whether to take the cash value as a lump-sum distribution or as a set of annuity payments for the remainder of the owner’s life. An early payout occurs when you surrender the policy before the annuity date. The annuity issuer may charge a nondeductible surrender fee for an early payout. You must include any annuity payments in excess of the annuity’s cost basis in your taxable income.
Qualified annuities reside in qualified employer plans such as 401(k)s, 403(b)s and 457s. You can also buy a qualified annuity in an individual retirement account, but this isn't a retirement plan. Contributions to qualified plans are tax-deductible, which means that these plans normally have no cost basis. If you take an early distribution, you might have to pay a surrender fee and will have to pay taxes on the surrendered amount. If you’re younger than 59 1/2, you also might have to pay a 10 percent early withdrawal penalty. You can avoid the penalty and postpone the tax if you roll over the distribution from a qualified plan to an IRA. You also might avoid the penalty if you qualify for an exception.
Qualified Annuity Penalty Exceptions
You don’t have to pay the early withdrawal penalty if you distribute the cash in equal periodic payments over your lifetime. You also avoid the penalty if you are disabled, have separated from your job at age 55 or older, have high medical expenses or if the money is paid to another payee because of a qualified domestic relations order. Other exceptions are available if you are assessed an Internal Revenue Service levy or if you are a reservist who is called to at least 180 days of active duty. Your beneficiary doesn't owe the 10 percent penalty if your death leads to an early distribution.
Nonqualified Annuity Penalty Exceptions
Certain employer retirement plans are not qualified for deductible contributions. You can’t roll a nonqualified annuity into an IRA, but certain other exceptions to the early withdrawal penalty apply to nonqualified annuities. You can receive an exception if the distribution stems from a personal injury settlement, if your employer provides you a nonqualified annuity after terminating a qualified retirement plan or if the annuity is an immediate contract that pays out equal periodic amounts beginning within one year from the lump-sum contribution.
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