3677 / What penalties apply to early distributions from an IRA?

Except as noted below, amounts distributed from a traditional IRA or a Roth IRA to the individual for whom the plan is maintained before such individual reaches age 59½ are early (premature) distributions. To the extent such distributions are taxable, they are subject to an additional tax equal to 10 percent of the amount of the distribution that is includable in gross income for that particular tax year.¹ The tax is increased to 25 percent in the case of distributions from SIMPLE IRAs ( Q 3706) during the first two years of participation.²

The 10 percent penalty tax does not apply to the following:

(1)   Distributions made to a beneficiary or the individual’s estate on or after the death of the individual.³

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Planning Point: If a surviving spouse is under age 59½ and elects to be treated as the owner of a decedent spouse’s IRA (generally, for required minimum distribution purposes), distributions may be subject to the early distribution penalty unless an exception applies. The early distribution penalty would not apply to distributions after the death of the original owner in the absence of the spouse making the election to be treated as owner.

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(2)   Distributions attributable to the individual’s disability.⁴

(3)   Distributions made for medical care, but only to the extent allowable as a medical expense deduction for amounts paid during the taxable year for medical care (determined without regard to whether the individual itemizes).⁵ Thus, only amounts in excess of 7.5 percent of the individual’s adjusted gross income (“AGI”) escape the 10 percent penalty. (The threshold amount was 10 percent between 2013-2016.)

(4)   Distributions made to unemployed individuals for the payment of health insurance premiums. The AGI floor, described above, does not have to be met if the individual has received unemployment compensation for at least 12 weeks and the withdrawal is made in either the year such unemployment compensation was received or the year immediately following the year in which the unemployment compensation was received. This exception also applies to self-employed individuals whose sole reason for not receiving unemployment compensation is that they were self-employed. The exception ceases to apply once the individual has been reemployed for a period of 60 days.⁶

(5)   Distributions made to pay “qualified higher education expenses” during the taxable year for the taxpayer, the taxpayer’s spouse, or the child or grandchild of the taxpayer or the taxpayer’s spouse.⁷ “Qualified higher education expenses” means tuition, fees, books, supplies, and equipment required for the enrollment or attendance of the student at any “eligible educational institution.” For tax years beginning after 2001, this includes expenses for special needs services in the case of a special needs beneficiary that are incurred in connection with such enrollment or attendance. Room and board (up to a certain amount) also is included if the student is enrolled at least half-time.⁸ “Qualified higher education expenses” must be incurred for the taxable year of the distribution.⁹ These expenses must be reduced by any scholarships received by the individual, any educational assistance provided to the individual, or any payment for such expenses (other than a gift, devise, bequest, or inheritance) that is excludable from gross income.¹⁰ An “eligible educational institution” is any college, university, vocational school, or other postsecondary educational institution described in Section 481 of the Higher Education Act of 1965.¹¹ Thus, virtually all accredited public, nonprofit, and proprietary postsecondary institutions are considered eligible educational institutions.¹² This exception to the 10 percent penalty is not available if the withdrawal qualifies for one of the other exceptions provided under IRC Section 72(t)(2) (other than the following exception for “qualified first-time homebuyers”).¹³

(6)   Distributions that are “qualified first-time homebuyer distributions” ( Q 3673). This exception to the 10 percent penalty is not available if the withdrawal qualifies for one of the other exceptions provided under IRC Section 72(t)(2).¹⁴

(7)   Distributions that are part of a series of substantially equal periodic payments made (at least annually) for the life or life expectancy of the individual or the joint lives or joint life expectancy of the individual and his or her designated beneficiary ( Q 3679).¹⁵

(8)   Distributions that are “qualified hurricane distributions” (these distributions may not exceed $100,000).¹⁶ See Q .

(9)   Distributions that are “qualified reservist distributions.” Qualified reservist distributions are those made to reserve members of the U.S. military called to active duty for 180 days or more at any time after September 11, 2001. Reservists have the right to return the amount of any distributions to the retirement plan for two years following the end of active duty.¹⁷

The penalty tax has been held not to apply to compulsory distributions where the IRS levied on a taxpayer’s IRA and where the federal government seized a taxpayer’s IRA as part of a plea agreement.¹⁸

Where a taxpayer withdrew from his IRA to satisfy a court order to pay alimony and child support, the penalty tax did apply.¹⁹