Thinking about tapping into your retirement savings early? It might seem like a quick financial fix, but it comes with tax consequences. Before withdrawing, it’s important to understand how the IRS treats early distributions and how they impact your bottom line.
The 10% early withdrawal penalty
If you take money from a traditional IRA or 401(k) before age 59½, the IRS imposes a 10% early withdrawal penalty. This penalty is in addition to the regular income tax you owe on the distribution. For example, if you withdraw $10,000, you could owe $1,000 in penalties plus any applicable income taxes.
Exceptions to the penalty
Some early withdrawals qualify for penalty-free treatment. These exceptions include:
- First-time home purchases (up to $10,000 from an IRA)
- Qualified education expenses
- Unreimbursed medical expenses exceeding 7.5% of adjusted gross income
- Disability
- Substantially equal periodic payments (SEPP)
- Birth or adoption expenses (up to $5,000)
Even if an exception applies, the withdrawn amount may still be subject to income tax.
Tax differences between Roth and traditional accounts
Withdrawals from Roth IRAs have different rules. Since contributions are made with after-tax dollars, you can withdraw them tax-free anytime. However, earnings on those contributions are subject to taxes and penalties if taken before age 59½ unless an exception applies.
Traditional accounts, on the other hand, are funded with pre-tax dollars, meaning the entire withdrawal is taxable as income. This can push you into a higher tax bracket, increasing your overall tax liability.
Planning to reduce taxes
To minimize tax consequences, consider alternatives before withdrawing early. A loan from a 401(k) avoids penalties if repaid on time. If possible, wait until you’re eligible for penalty-free distributions or use taxable savings instead. Careful planning can help preserve your retirement funds while reducing tax burdens.
