Misterpopo - The Financial Expert

Tax laws promote participation in retirement plan accounts. Whether you save for retirement through your employer’s plan or on your own with an Individual Retirement Account (IRA), you’ll typically defer the payment of taxes on income that you contribute to the plan.

Beware that if there’s an early withdrawal or distribution from your tax qualified plan, you’ll likely have to pay a penalty tax. The penalty tax is in addition to any income tax you owe. Fortunately, the tax code contains a number of exceptions to the penalty tax. Exceptions to the penalty recognize that withdrawals from these accounts are sometimes unavoidable.

It seems that no matter what you do with your retirement  money, there is a tax  penalty  lurking around a corner. Retirement plans have limits to the amount of money you can contribute to them annually. For individual retirement accounts, this amount is a relatively tiny $5,000 for each of 2008 and 2009. If you are age 50 or above before the close of the taxable year, you may contribute an additional $1,000. If you contribute more than you are allowed to, you will be assessed a 6 percent excise tax on the excess amount and its earnings. If you try to withdraw funds from your retirement account before you turn 59½, you may be subject to an additional 10 percent penalty.

The General Rule:
Typically, if there’s a withdrawal or distribution from your qualified plan or your IRA account before you’re 59 ½ , you’ll owe an additional income or penalty tax. This penalty tax also applies to distributions from a governmental 457(b) plan if the distribution results from amounts rolled over from a plan subject to the tax. The amount of the tax is 10% of the amount includable in your income. The tax doesn’t apply to parts of the distribution that aren’t taxable.

You must begin receiving distributions  from most retirement plans by April 1 of the year after you turn 70½. However, waiting till the year after you turn 70½ to begin taking distributions could result in extra taxes for that year because two distributions will be required in the same year—one for the year in which you turned 70½ and one for the current year. If you take out too little, you will be hit with a 50 percent penalty on the difference between the required minimum distribution and the amount you actually withdrew.

You must withdraw your minimum distribution by December 31 in any year distributions are required. As you can see, you can save a considerable amount of money if you know and follow the rules for avoiding tax penalties.

Exceptions to the Penalty Tax
There might be a pressing reason for your early withdrawal or distribution. These situations are reflected in the 18 exceptions to the penalty tax.

The exceptions from the penalty tax are:

• Any distribution made to a beneficiary, or to the estate of the employee, on or after the death of the employee
• Any distribution due to the employee’s being disabled, as defined in IRC § 72(m)(7)
• Any distribution that is part of a series of “substantially equal periodic payments,” made at least annually, for your life, or over your life expectancy or that of you, as the employee, and your designated beneficiary. There are additional rules that apply to this exception, such as when payments must start. If the distribution isn’t from an IRA, the payments must start when you leave your job. If the payment plan is later modified, you might face a penalty
• Any distribution made after 1999, on account of an IRS levy on the plan under IRC § 6331
• Any distribution, to the extent that it isn’t more than the amount that you could claim as a tax deduction for medical expenses during the year of the distribution. It doesn’t matter whether you actually itemize deductions for that year
• Any distribution of excess deferrals (and income on those amounts), from a 401(k) plan, 403(b) plan, SARSEP or SIMPLE IRA
• A ”qualified reservist distribution.” This is a distribution that is made (1) from an IRA, or attributable to elective deferrals under a 401(k) or 403(b) plan; (2) to a reservist who is called or ordered to active duty for more than 179 days or for an indefinite period; and (3) during the period beginning on the date of the call or order to duty and ending at the close of the active duty period. The exception applies if the call or order to duty was made on or after December 31, 2007
• Effective distributions made after August 17, 2006, distributions from a governmental defined benefit plan to a public safety employee (police officer, firefighter, or emergency medical services employee) after separation from service after reaching age 50
• A permissible withdrawal from an eligible automatic contribution arrangement under a qualified plan or 403(b) plan

Exceptions Applicable to IRAs
This set of exceptions applies only to distributions from your IRA and includes:

• Distributions to pay for health insurance after you’ve been separated from your job if you’ve received unemployment compensation for at least 12 weeks due to that separation. The distribution must be made during the year that the unemployment compensation is paid, or in the following year, the amount can’t be more than the amount paid during the year for health insurance for yourself, your spouse, and your dependents, and the distribution is made before you’ve been reemployed for 60 days after the separation
• Distributions from an IRA that don’t exceed your qualified higher education expenses for the year. This includes expenses for certain family members
• A qualified first time home buyer distribution. There’s a $10,000 lifetime limit on this exception

Exceptions Not Applicable to IRA Distributions
There are a number of exceptions that don’t apply to IRA distributions:

• Any distribution made to an employee after separation from service after age 55. The Internal Revenue Service (IRS) interprets this exception as applying if the separation from service happens during or after the calendar year in which you reach 55
• Any distribution of a dividend, with respect to stock held by an ESOP, which is deductible under IRC § 404(k)
• Any distribution to an alternate payee under a qualified domestic support order (QDRO)
• Any distribution of excess contributions, which are contributions in excess of the amount permitted by the actual deferral percentage test, to a highly compensated employee
• Any distribution of excess aggregate contributions, which are contributions in excess of the amount permitted by the actual contribution percentage test, to a highly compensated employee
• Any distribution of benefits with respect to which an election is in effect under § 242(b)(2) of TEFRA. This section of the tax code dates to the 1980’s and is a grandfather clause that allows certain profit-sharing plan participants, owning more than 5% or more of a company, to elect to defer distributions

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