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July 18, 2024

Understanding Exceptions to the 10% Early Withdrawal Tax from Retirement Accounts

Purpose

The IRS and Treasury Department have released new guidelines to help people understand when they can take money from their retirement accounts early without paying an extra 10% tax. These exceptions apply to situations like personal emergencies and domestic abuse.

Background

Usually, if you take money out of your retirement plan before you turn 59 ½, you have to pay an extra 10% tax on that money. This is on top of the regular income tax. The rules aim to discourage people from using their retirement savings too soon. However, there are exceptions to this rule.

Types of Retirement Plans Covered

The rules below apply to several types of retirement plans:

401(k) plans: These plans are retirement savings plans offered by employers.
Annuity plans: These types of plans provide regular payments over time and are usually used as part of retirement planning.
403(b) plans: These retirement plans are similar to 401(k) plans but are for employees of public schools and certain tax-exempt organizations.
IRAs (Individual Retirement Accounts): These plans include traditional IRAs and annuities described in sections 408(a) and 408(b) of the tax code.

Existing Exceptions to the 10% Tax

There are already some situations where you can avoid paying the extra 10% tax:

Age 59 ½ or older: If you wait until you're at least 59 ½ to take money out, you don't pay the extra tax.
Death: If you die, your beneficiary or estate can take the money out without paying the extra tax.
Disability: If you become disabled, you can withdraw money without the extra tax.
Equal payments: If you take out the money in equal payments over your lifetime or the joint lifetimes of you and your beneficiary, you don't pay the extra tax.
Retirement after age 55: If you leave your job and are at least 55 years old, you can take money from your retirement plan (not an IRA) without the extra tax.

New Exceptions Under the SECURE 2.0 Act

On December 29, 2022, the SECURE 2.0 Act was enacted, and this law introduced new exceptions to the 10% tax for early withdrawals, including the following:

Emergency Personal Expenses

The new law allows you to take money out for emergencies without paying the extra 10% tax. This is called an "emergency personal expense distribution."

Even though you avoid the extra tax, you still have to report the withdrawal as income and pay regular income tax on it. This exception helps people access their retirement funds in urgent situations without facing a financial penalty.

Domestic Abuse Victims

Another new exception is for victims of domestic abuse. If you are a victim of domestic abuse, you can take money out of your retirement account without paying the extra 10% tax. This aims to provide financial relief and support to those escaping abusive situations, helping them rebuild their lives.

Summary

The IRS has detailed new guidelines for avoiding the 10% early withdrawal tax on retirement accounts in emergencies and for domestic abuse victims.

Normally, taking money out before age 59 ½ means paying an extra 10% tax.

Existing exceptions include being 59 ½ or older, death, disability, equal payments, and retirement after age 55.

New exceptions under the SECURE 2.0 Act include emergency personal expenses and domestic abuse.

Key Takeaways

If you need to take money out of your retirement account early, check if you qualify for an exception to avoid the extra 10% tax.
The new exceptions for emergencies and domestic abuse provide important financial relief options.
Make sure to report any withdrawals as income and pay the regular income tax.

Conclusion

The new guidelines and exceptions to the 10% early withdrawal tax aim to provide financial flexibility in times of need, such as emergencies and situations of domestic abuse.

These exceptions to the 10% tax are only available if the Plan Document. SECURE 2.0 made these new laws discretionary.

Contact your administrator at Benefit Equity Inc. for more information and whether amending your plan to adopt these rules is right for you.

Understanding these rules can help you make informed decisions about your retirement savings. The government is actively seeking public input to ensure these guidelines are effective and helpful for those who need them.

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