For the most part, any person who withdraws funds from his or her tax-deferred 401k or IRA account before reaching age 59 1/2 will end up paying 40% or more in income taxes and penalties.  You may ask the financial institution to withhold taxes, and they will do so, but only up to a certain amount.  The remaining amount (the penalties) will be calculated and assessed during income tax preparation season.  This is when you will feel the painful sting of early withdrawal.   For example, a person who has withdrawn $20,000 from retirement funds to pay off credit card debt will very likely pay roughly $8,500 in federal income tax, state income tax, and early withdrawal penalties.

There are, however, a few exceptions to the rule in regards to the penalty. The main exceptions are have to do with major life occurrences. For example:

  1. Death – If you received the withdrawal as a beneficiary of someone who is now deceased.
  2. Medical – If you have proof you used the funds to pay for medical expenses, or if you were laid off work and used the funds to pay for medical insurance while unemployed.
  3. Lost of work due to permanent disability or if you were laid off work and you’re age 55 or over.
  4. To pay for higher education expenses for your self, your spouse, or your children.
  5. To pay an IRS levy.
  6. First time purchase of a home.

I recommend you consult with a qualified tax preparer to see if you meet all of the qualifications for any of these exceptions. If you’re in California, I can help you with your tax preparation as well.  Click here to send me a private message.

Michelle Walker-Wade, IRS Registered Tax Preparer
Michelle Walker-Wade, IRS Registered Tax Preparer

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