If You Retire Early, Watch Out for IRS Penalties

Aug 25, 2021

By Theresa Fry, Senior Vice President and Manager, IRA’s, Retirement & Education Planning

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If there is one thing that this past year and a half has taught us, it’s that life doesn’t always go according to plan. If you find yourself in a situation where you are retiring early – whether by choice or by circumstance – and you need to access the money in your retirement accounts earlier than you expected, it’s important to understand what options you have and the tax impacts of accessing retirement accounts early.


  • IRA Withdrawals – The IRS considers all IRA withdrawals before the age of 59½ to be premature distributions. In addition to paying income taxes on IRA distributions, the IRS generally imposes an additional 10% early withdrawal penalty. With SIMPLE IRAs, the penalty increases to 25% if the distribution is taken within the first two years of participation in the plan. However, there are certain circumstances when premature IRA distributions are not subject to the penalty such as when distributions are used for a first-time home purchase or for higher education expenses. A few other reasons are discussed later.
  • Roth IRA Withdrawals – Roth IRAs offer a unique opportunity for access to your retirement savings. Roth IRA distributions are made in a specific order:
    • Annual Roth IRA Contributions. First, your annual contributions are distributed, and because contributions to a Roth IRA are after-tax, you are able to withdraw up to the amount contributed at any time without having to pay income taxes or IRS penalties.
    • Conversion Contributions. Next, if you funded a Roth IRA through a conversion of assets from a traditional IRA or employer-sponsored retirement plan, you may also withdraw up to the amount converted without paying taxes (because taxes were paid at the time of conversion). However, the 10% early withdrawal penalty will apply if you are younger than age 59½ and the converted balances are distributed in the first five years following the conversion. Under certain circumstances, an exception to the 10% penalty may apply.
    • Earnings. Last, any earnings on your contributions that are withdrawn before you satisfy both the five-year holding period and age 59½, will be taxable and subject to the 10% penalty (unless an exception to the penalty applies).

401(k) and Other Employer-Sponsored Retirement Plans

  • “55 and Over” Exception – If you are, or will be, age 55 or older in the year you separate from service, distributions paid to you from a retirement plan are not subject to the 10% early withdrawal penalty. However, 20% of the distribution will be withheld (and sent to the IRS) and the entire amount will be taxed as income unless rolled over to an IRA or another eligible retirement plan within 60 days. If you elect to do a direct rollover to an IRA, the “55 and over” exception no longer applies to withdrawals taken from the IRA after the rollover is completed.
  •  Plan Loans – Many employers allow employees to borrow from their 401(k) or retirement plan account balances. Employers are not required to offer plan loans and taking out a new loan after you retire may not be available to you. If you received a plan loan previously and have an outstanding loan balance, your loan payments were most likely coming directly out of your paychecks. Failure to continue making timely loan payments to repay the outstanding loan once you retire can be costly. If you default on the plan loan, you’ll owe income taxes on the outstanding loan balance and possibly a 10% IRS early withdrawal penalty.

Penalty-Free Withdrawals Available from Both IRAs and Employer-Sponsored Retirement Plans

  • Substantially Equal Periodic Payments or 72(t) Distributions – A 72(t) distribution can be taken for any reason, but there are restrictions on the timing and the amount of the payments. The distributions must be substantially equal, made not less frequently than annually, determined using one of three IRS-approved methods, and be received for the longer of five years or until age 59½. They are taxable but are not subject to early withdrawal penalties unless you modify the payments once they have begun. With an IRA, 72(t) payments can begin at any time. But if you have an employer-sponsored retirement plan, the payments can only begin after you separate from service.
  • Disability and Medical Expense Withdrawals – If you have a physical or mental disability – expected to be of long, continued, or indefinite duration – which keeps you from being able to work, or if you have unreimbursed medical expenses, you may also receive penalty-free access to your retirement accounts. Distributions for total and permanent disability are not limited. However, unreimbursed medical expenses must exceed 10% of your adjusted gross income (AGI) in order to qualify. In either case, the distributions will be subject to income taxes.

Because retirement savings accounts offer tax advantages that other savings accounts don’t, make sure you have considered other possibilities first before taking a withdrawal from your 401(k) or IRA. Besides those discussed above, there are other exceptions that may also apply. Your financial advisor can help you understand which alternatives are available to you. In addition to income taxes and penalties, the loss of tax-deferred growth is also a consideration you should review with your tax professional before taking an early retirement account withdrawal.


Benjamin F. Edwards does not provide tax advice; therefore, it is also important to consult with your tax professional for additional guidance tailored to your specific situation.