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How to Avoid the 10 Percent Early Withdrawal Penalty

How to Avoid the Early Withdrawal Penalty

Typically, with a retirement plan, such as an IRA, 401(k), 403(b), SEP or SIMPLE IRA there is a 10% early withdrawal penalty on withdrawals before age 59 ½.  This means you will have to pay federal income tax, state tax and a 10% penalty, (for some accounts like SIMPLE IRA the penalty may be as high as 25%!).  You may get less than half of what you were originally expecting.

There are so many ways around this penalty, almost no one should ever have to pay it.  Not every method works for every account type, but there is a tactic for just about any situation.  In no particular order:

Wait until you are 59 ½

The easiest way to avoid a penalty is to wait until you are over 59 ½ before taking withdrawals from a qualified account.  Plan ahead of time and have enough in your bank accounts or other non-qualified investments to cover any early retirement expenses.  This is not always possible, and there are other ways to avoid the penalty.

Wait Until You Are 55, and Separated From Service, Withdrawal From Employer Qualified Plan

In certain employer sponsored retirement plans(401(k) TSP, 403(b)), if you are separated from service, and over 55 years old, any distributions are not subject to the early withdrawal penalty.  Some employers may allow you to roll over your IRA into your employer’s retirement plan, that will allow you to withdraw without paying a penalty.

Loan From Qualified Plan

When the administrator allows it, from certain qualified plans, you can take a loan against your plan balance.  The maximum you can take as a loan is the lesser of ½ your vested balance or $50,000.  For example, if your vested balance is $20,000, you can get a $10,000 loan.  And if your vested balance is $200,000 you can take a $50,000 loan.  You will have to pay back the loan, plus interest.  However, you are paying interest to yourself, putting more back into your plan.  One potential drawback, if you separate from service before the loan is paid off, you may be subject to the 10% early withdrawal penalty.

Take Contributions From ROTH IRA After 5 Years

If you have a ROTH IRA, that has been open for more that 5 years, you can take your contributions out without paying either tax or penalty.  However, if you withdraw more than your contributions and start taking earnings, you will have to pay both penalty and income tax.  This strategy is not applicable to employer sponsored plans, only IRAs.

ROTH Conversion

If you do not have a ROTH IRA but believe you will need to take withdrawals in more than 5 years, but before you are 59 1/2, you can use a ROTH conversion strategy.  This involves 1. Converting funds from a traditional IRA to a ROTH IRA. 2. Paying tax on the amount converted. 3. Waiting five years. 4. Withdrawing less than the amount converted, NOT any of the gains.

Use a 457

If you use a 457 qualified employer sponsored plan, and you are separated from service, the withdrawals are penalty free. It does not matter how old you are.  You will still need to pay ordinary income tax on the withdrawal.  This can be a great strategy for those who want to control their tax rate, and change jobs often.


It is not a recommended method, but if you were to die, your beneficiaries would be able to withdraw your qualified investments without any penalty.  

72(t) Payments

These are often referred to as Substantially Equal Periodic Payments (SEPP).  It requires you to receive equal payments, for at least 5 years or until you reach 59 1/2 whichever comes later. The payments are based on your age and investment amount.  It can be restrictive in how much you must take.  It should probably not be your first choice, but if you need consistent income from your IRA for at least the next 5 years, it is a tool in your toolbox.

Excluded Withdrawals From IRA

  • Medical Expenses
  • Disability
  • First time home purchases
  • Higher education expenses
  • Health Insurance during unemployment
  • Military reservists called to active duty
  • IRA IRS Levies

If you are withdrawing from an IRA and have had any of the above expenses in the past year, it could be penalty free.  There are exclusions and requirements for each.

This is not an exhaustive list.  There are other tactics or strategies that may apply to you.  Unless something extreme is happening, and you don’t have time to plan, you should not have to pay any early withdrawal penalties.  Before you make a withdrawal, give us a call.  Maybe we can save you hundreds or thousands in penalties.