With the burst of the housing bubble, many people don’t have the luxury of tapping the equity in their home to fund large purchases. What some have resorted to instead are early distributions from their retirement plans. Most people don’t realize the tax consequences that go along with these early distributions.
Generally, distributions that you receive before the age of 59½ are considered “early distributions.” In addition to being taxable income in the year received, these distributions are usually subject to an additional 10% penalty tax. You can avoid the 10% penalty if you roll over your early distribution to another qualified plan within 60 days of receipt. A direct roll over from qualified plan to qualified plan will also avoid the 10% penalty.
There are also some limited exceptions to the 10% penalty, such as when you use the distribution to purchase your first home (up to $10,000), to pay for certain medical expenses, or if you are totally disabled. Publication 575, Pension and Annuity Income, and Publication 590, Individual Retirement Arrangements (IRAs) provide more information.
It’s usually best to avoid raiding your retirement plan at all, but if you need the cash and want to avoid the tax and penalty, you might want to consider a loan from your retirement plan instead. A loan is not considered taxable income or a distribution so there is no penalty. Better yet, talk to a financial advisor to weigh other possible (and hopefully less costly) options for your financing needs.