Despite the tax penalty, it is not unusual for individuals to withdraw money from their retirement accounts before age 59 1/2. The tax code provides exceptions to the penalty for several qualifying reasons. Persons age 55 or older who have left their jobs and withdrawn funds from a 401(k) account may qualify for an exception to the penalty.
Age 59 1/2 is generally the age at which retirement account funds may be withdrawn without penalty. At a younger age, a 10 percent penalty is typically assessed on the withdrawal. Although not available to owners of individual retirement accounts, employees with a 401(k) account may avoid the penalty if they leave their employer at age 55 or over.
The age 55 exception
The 401(k) penalty exception becomes effective the year in which the account holder reaches age 55. Regardless of how the employment relationship ends, the final day of work must be within or after the year in which you reach age 55.
If you begin a calendar year at age 54, reaching age 55 by the end of the year, the exception applies if you leave the employer. If you end a work relationship at age 54, but withdraw your 401(k) balance the following calendar year in which you reach age 55, the exception does not apply.
A 401(k) account is referred to as a qualified retirement plan. For public safety employees in a traditional pension plan with a defined benefit, the penalty exception becomes effective at age 50.
Form 1099-R
Recipients of retirement account distributions receive IRS Form 1099-R from the account payer for tax preparation purposes. Withdrawals from 401(k) accounts are reported as ordinary income for the year in which they are received. Form 1099-R must be properly coded for you to automatically receive the penalty exception. If Form 1099-R does not correctly specify the exception, another form is necessary.
Form 5329
IRS Form 5329 is used to clarify your 401(k) penalty exception if you received a Form 1099-R with an incorrect distribution code. Account payers sometimes enter distribution code 1 in error, indicating no known exception. Form 5329 is typically part of a tax return, but it can be filed by itself if there is otherwise no filing requirement.
The are other potential exceptions to the penalty on early withdrawals from retirement accounts. Contact a tax preparer, like Jack Landis And Company, for more information about the tax implications of retirement account activity.
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