Redeeming funds early from your retirement account can be a complicated process. Many retirement plans have built-in penalties if you redeem funds before you are 59 1/2 years old. You should know the specific requirements for your plan thoroughly before deciding if early redemption is the right choice for your situation.
Steps for Early Redemption
If you are considering redeeming funds early, you should contact the administrator of your retirement plan. Most plans will require that you fill out certain forms to redeem funds early and allow you to choose between receiving funds as periodic payments or as one lump sum. For example, if you have a 401(k), you will need to fill out a 401(k) distribution request form. In addition, you will need to file an IRS Form 5329, which calculates any penalties and allows you to list exceptions for which you might qualify. You will also need to report any funds you receive on IRS Form 1040 or 1040A.
Qualified Retirement Plan Penalties
Qualified retirement plans are a common type of retirement fund. These include any plans that meet the requirements for IRS Tax Code 401(a), 403(a), 403(b) or 408(a). These plans include 401(k)s, certain annuity plans and IRAs. Qualified retirement plans all fine a 10 percent penalty if you withdraw funds before the age of 59 1/2. In addition, any money you withdraw will be taxed as ordinary income.
Exceptions to the 10 Percent Penalty
A number of exceptions may help you avoid the additional 10 percent tax on qualified retirement plans. If you roll the funds over into a different qualified retirement plan, you will not be penalized. You can also avoid the 10 percent tax if you meet any of a number of exceptions detailed in IRS Tax Topics 557 and 558. These exceptions include being permanently disabled, medical expenses that exceed 7.5 percent of your adjusted gross income and some other qualified reservist distributions. If the plan is not an IRA, you will also be exempt if you separated from your employment after age 55 (or after 50 if you worked for the government).
Deferred Compensation Plans
A section 457 deferred compensation plan is a retirement plan funded only by employee contributions. This plan is a supplement to any mandatory retirement plans you have. A state or local government section 457 retirement plan is usually not subject to the additional 10 percent tax for early withdrawals. The plan's administrator will know if any other penalties are written into the plan.
The 10 percent penalty may not be the only one you have to pay for redeeming retirement funds early. Some plans have their own penalties in addition to those of the IRS. In addition, if you need funds quickly, there may be a fee to expedite your receipt of the money. You may want to consult with a financial adviser before making any decisions about withdrawing retirement funds early.
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