10% Early Withdrawal Penalty for Retirement Accounts

The IRS offers valuable tax benefits to encourage retirement savings. Plans like 401(k)s, IRAs, and the Thrift Savings Plan provide tax advantages that help investors grow their retirement funds more efficiently.

These tax-advantaged plans allow investors to defer paying taxes on their contributions in Traditional accounts, such as 401(k)s and Traditional IRAs, until they withdraw the funds in retirement. Roth accounts, on the other hand, are funded with after-tax money, meaning qualified withdrawals are tax-free.

But these tax benefits come with a catch. Most retirement accounts impose a 10% early withdrawal penalty if you take money out before reaching age 59½. However, there are exceptions, such as penalty-free withdrawals of Roth IRA contributions and certain qualifying distributions from Traditional accounts.

In addition, distributions from Traditional IRAs, 401(k) plans, the TSP, and most other retirement plans are considered taxable and will be included as income the year you withdraw the money. This means you will also pay taxes on those withdrawals.

Let’s examine the impact of early retirement account withdrawals and some options to avoid IRS penalties.

Summary

• Early withdrawals usually incur a 10% penalty plus income taxes, except for Roth IRA contributions
• Certain exceptions—like medical expenses, disability, and first-time home purchases—may allow penalty-free withdrawals.
• 401(k) and TSP loans avoid penalties if repaid; otherwise, they’re taxed as early withdrawals.

Tax Consequences of Early Withdrawals from Retirement Accounts

Withdrawing money from a Traditional IRA, 401(k), or similar retirement plan before age 59½ typically triggers a 10% penalty, unless you qualify for an exception, such as a first-time home purchase (IRA), medical expenses, or certain hardship withdrawals. You may face a 10% penalty if you withdraw earnings—not contributions—from a Roth IRA before age 59½ and before the account has been open for at least five years, unless an exception applies.

As mentioned above, withdrawals, or distributions, from many retirement accounts are classified as taxable income. Taxes on this income will apply on top of the 10% penalty.

In some situations, you may avoid the 10% penalty, but early withdrawals from Traditional retirement accounts are still considered taxable income. However, Roth IRA contributions (not earnings) can be withdrawn tax- and penalty-free.

If you withdraw funds from a SIMPLE IRA within the first two years of participation, the early withdrawal penalty increases to 25%. After two years, the standard 10% penalty applies.

Exceptions to 10% Early Withdrawal Penalties

A few situations allow individuals to take early distributions from their retirement accounts without paying a 10% penalty. These can be broken down into exceptions for IRAs and employer-sponsored plans, such as 401k plans.

Early Withdrawals from IRAs

If you have an individual retirement account (either a Traditional IRA or Roth IRA), the following are allowed exceptions for early withdrawal of your retirement account without having to pay a 10% penalty:

• Completing a direct rollover to your new retirement account
• You become permanently or completely disabled
• You became unemployed and used money from a retirement account for health insurance premiums
• You use the money for your own college expenses or the college expenses of your dependent(s)
• You pay for medical expenses that cost more than 7.5% of adjusted gross income
• The IRS withdrew the money as a tax levy to pay for tax debts owed
• You use up to $10,000 of your retirement account money to purchase a home and have not owned a home in the last two years.

Note: You can withdraw Roth IRA contributions without penalties, but not the earnings from those contributions. Learn more about Roth IRA withdrawal guidelines to ensure you follow the IRS rules correctly.

Early Withdrawals from Employer-Sponsored Retirement Plans (401k, TSP, etc.)

If you are withdrawing money from a 401(k) or 403(b) plan, the following situations are considered exempt from the 10% early withdrawal penalty:

• The money was required due to a qualified domestic relations court order in a divorce or separation agreement.
• You left your job or retired after the age of 55.
• Distributions were received due to the death or disability of the retirement plan participant.
• You used the money to pay for more than 7.5% of your adjusted gross income for medical expenses.
• You received the money from your retirement account in substantially equal payments throughout your lifetime.

You will want to speak with a qualified tax professional or investment advisor to ensure you communicate this appropriately to the IRS when you file your tax return if any of the above apply to your situation.

How to Report Early Withdrawal Penalties

If you make an early withdrawal from your retirement account, you must report the penalty and additional taxes using Form 1040 or Form 5329.

Failure to repay a TSP loan or TSP Hardship Withdrawal may also trigger early withdrawal penalties.

Most tax software programs can help you report this to the IRS and calculate any penalties or taxes owed. If not, then work with a qualified tax professional. The last thing you want to do is add penalties and fees for failing to file correctly, on top of the 10% early withdrawal penalty.

Should I Withdraw Money From My Retirement Account?

Balancing long-term and short-term financial goals can be difficult – it seems like something always pops up. Whether it’s debt, a major purchase, or an unexpected expense, it can be tempting to dip into your retirement savings for the cash to take care of your new expense.

The problem is unless you are at the IRS retirement age of 59½, withdrawing funds from your retirement account may result in a large portion of the withdrawal being eaten up by taxes and penalties. You are also hurting your long-term financial plans by reducing the amount of money you will have available when you retire.

The Real Costs of Withdrawing Retirement Funds Early

Many people regret making early withdrawals from their retirement accounts. Here’s why it can be a costly mistake:

Taxes

The first thing that is going to get you is the taxes. Qualified retirement plans such as IRAs and 401(k) plans (and others) have some nice tax advantages. When you invest in a Traditional retirement plan such as a Traditional IRA or 401(k), the money is not taxed until you withdraw it.

This is designed to allow you to invest more money upfront and give you years of tax-free growth. When you withdraw that money early, you lose that tax advantage and must pay the taxes immediately.

Early Withdrawal Penalties

Early distributions from an IRA, 401(k), 403(b), or other qualified retirement plans are subject to a 10% early withdrawal penalty.

That means your withdrawals are taxed, and an additional 10% is taken from the withdrawal to pay the penalty. Double-whammy!

Less Money for Future Growth

Compound interest is the most important thing you have working for your retirement. The more time compound interest works in your favor, the more money you will have when you retire.

Leaving your money in your retirement accounts means you will need to save and invest less money over your remaining working years. It’s better to get ahead now instead of trying to catch up with your retirement savings when you are older.

Possible Market Losses

If your retirement account has lost value, withdrawing funds early locks in those losses, and you may still owe taxes and penalties on the amount withdrawn. Leaving investments in the account allows them time to potentially recover.

Leaving the money in your investments gives them time to appreciate and regain their previous value and hopefully appreciate beyond your original investment.

TSP & 401k Loans Can Be Subject to Early Withdrawal Penalties if Not Repaid

Some people don’t know they can take a loan on their TSP or 401k. Depending on how much is in your 401k, you can secure a loan based on that money. These loans are not subjected to any taxes or penalties. You can contribute to the plan while you’re paying back the loan. In most cases, you’ll be able to take out a loan that is around 50% of the total value of your account.

One of the main disadvantages of taking out a 401(k) loan is that if you were to leave before you paid back the loan, you would be responsible for paying back the remaining balance. Failure to repay the outstanding loan will result in immediate taxes and early withdrawal penalties, which can compound an already bad situation.

Also, when you take out a 401(k) loan, you will receive dollars that have not yet gone through income taxes and then pay that loan back with dollars that have been taxed. When you withdraw the money at retirement, those withdrawals will be taxed again. When you repay a 401(k) loan, the repayments are made with after-tax dollars, and the money is taxed again when withdrawn in retirement. While this results in taxation at two points, it differs from traditional ‘double taxation’ because the original contributions were made pre-tax.

On the flip side, there are some benefits to these plans. If you’re ever in need of money, then taking out a loan is going to be a much better idea than withdrawing your money. These loans will give you access to money quickly, at a low-interest rate, and they won’t appear on your credit score.

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