IRA penalty exceptions

ARTICLE TAKEAWAYS

  • Distributions to IRA owners under the age of 59½ are subject to taxes and penalties
  • The Internal Revenue Service (IRS) allows for exceptions to the penalty in some cases

A distribution is the withdrawal of assets from an IRA that may result in tax consequences and penalties. Distributions to IRA owners under the age of 59½ are considered early distributions. Deductible contributions and earnings are subject to taxes, and unless an exception applies, a 10% early distribution penalty will be incurred. For SIMPLE IRAs, if the participant has not been in the plan for at least 2 years, the penalty increases to 25%.

Exceptions

The IRS early distribution penalty does not apply if the distribution falls under certain exceptions. These exceptions are referred to as 72(t) provisions because they fall under Internal Revenue Code (IRC) Section 72(t).

Some (but not all) examples of distributions that are exempt from the early distribution penalty include:

  • Beneficiary distributions
  • Disability distributions
  • Substantially equal periodic payments
  • Birth or adoption expenses*† (Distributions must be made within 1 year after the birth or adoption date and are limited to $5,000 across an investor’s accounts per birth or adoption.)
  • Certain medical expenses*
  • Health insurance premiums during unemployment*
  • First-time home purchase expenses (up to $10,000 per individual)*
  • Qualified higher education expenses*
  • Qualified reservist distributions*
  • Distributions made while terminally ill*
  • Distributions made in connection with federally declared disasters (up to $22,000 per individual)*
  • Distributions for unforeseeable or immediate financial needs related to necessary personal or family emergency expenses (up to the lesser of $1,000 or the excess of your account balance over $1,000)*
  • Distributions due to domestic abuse (up to the lesser of $10,000 as adjusted for inflation or 50% of the account balance)*


* Capital Group does not require documentation on these distributions. If made before age 59½, they are reported to the IRS as early distributions, with no known exception (IRS Code 1) on Form 1099-R. Consult a tax advisor to determine whether a distribution falls under a particular exception.

† If your client wants to repay all or part of the distribution back to their IRA, they must do so within 3 years of the date they received the distribution.

Beneficiary distributions

For information about taxes and penalties on distributions due to the death of the account owner, contact us.

Disability distributions

The IRS considers a taxpayer to be exempt from the early distribution penalty if the individual’s condition meets the following definition of disabled in IRC Section 72(m)(7): “an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration.” Capital Group does not determine whether a disability qualifies for the exception.

Capital Group may be able to report the disability distribution code on Form 1099-R if a statement is provided from a physician indicating:
 
  • The date the disability occurred
  • That the account owner’s condition meets the IRC Section 72(m)(7) definition of disabled


Investors may also provide the necessary documentation to the IRS when filing their taxes.

Substantially equal periodic payments

The account owner must take distributions:
 
  • For 5 tax years or until the age of 59½, whichever is longer
  • At least annually
  • In substantially equal payments calculated using one of these methods:
    • Amortizing the IRA balance over a period equal to the life expectancy of the IRA owner or over the joint life expectancy of the IRA owner and their designated beneficiary
    • Annuitizing by dividing the IRA balance by an annuity factor
    • Taking required minimum distributions (RMDs) calculated over the IRA owner’s life expectancy or the joint life expectancy of the IRA owner and their beneficiary

Note: If the payment amount changes before the end of the required substantially equal periodic payment schedule, the tax penalty applies to all distributions, including any previous ones. However, investors may make a one-time change from the amortization or annuitization calculation method to the RMD method, which may reduce the amount of their distributions.

Note: If an account owner depletes their account before the end of the required distribution period, they will not be subject to the tax penalty.

Qualified higher education expenses

Qualified expenses for an eligible institution generally include:
 
  • Tuition
  • Mandatory fees
  • Required textbooks, supplies and equipment
  • Reasonable costs for room and board


Investors must report this exception when filing their taxes. Consult a tax advisor to determine whether a specific expense is qualified.

Qualified reservist distributions

Members of a reserve component called to active duty could take a penalty-free distribution from their IRA if they met the following criteria:
 
  • Ordered or called to active duty after September 11, 2001
  • Ordered or called to active duty for 179 days or more
  • The distribution was made no earlier than the date of the order or call to active duty and no later than the close of the active-duty period

Other exceptions

Capital Group does not determine whether a distribution meets the IRS requirements to avoid the early distribution penalty. Capital Group reports all other distributions before the age of 59½ as early distributions on Form 1099-R. Investors must report any exceptions when filing their taxes.

Additional information

Consult IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs) or a tax advisor for more information or with any questions you may have on exceptions to early distribution penalties. 

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