Tax Penalty for Early Withdrawal on Profit Sharing Accounts

By: Eric Bank, MBA, MS Finance | Reviewed by: Ryan Cockerham, CISI Capital Markets and Corporate Finance | Updated March 12, 2019

The IRS might punish you for an early withdrawal from a profit-sharing account.

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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, called distributions, are subject to penalties. If you receive distributions before the age of 59 1/2, the IRS imposes a 10 percent early-withdrawal penalty unless you roll over the distribution to another eligible retirement savings plan ... or unless you qualify for an exception.

Tip

Some exceptions that let you off the hook for having to pay the 10 percent penalty include your total and permanent disability, medical expenses that exceed 7.5 percent of your adjusted gross income and distributions that go to your beneficiaries or your estate after your death.

Identifying Valid 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.

Implications of 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.

Exploring 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

Eric Bank is a senior business, finance and real estate writer, freelancing since 2002. He has written thousands of articles about business, finance, insurance, real estate, investing, annuities, taxes, credit repair, accounting and student loans. Eric writes articles, blogs and SEO-friendly website content for dozens of clients worldwide, including get.com, badcredit.org and valuepenguin.com. Eric holds two Master's Degrees -- in Business Administration and in Finance. His website is ericbank.com.

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