IRA vs. 401(k)s: Exceptions to the 10% Penalty for Withdrawals Under Age 59½ Differ

There is a lot of confusion surrounding the IRS’s 10% penalty on early distributions from retirement plans. Most people know that this penalty exists for those who withdraw tax-deferred retirement funds before age 59½, though many don’t realize that it’s added to the current tax rate.

Many people have also heard that there are exceptions to the 10% penalty, although they rarely fully understand what those exceptions are and when they apply.

Today we’ll explain when and where these exceptions to early withdrawal penalties apply by dividing distributions into three different groups: traditional IRAs, non-IRA retirement plans, and finally, a group that includes both IRAs. Y retirement plans

Exceptions to the 10% Penalty: For IRA Accounts Only

The traditional IRA penalty exceptions are the ones most people have heard of, but they often assume they apply to any type of plan, which isn’t necessarily the case. The following exceptions are strictly limited to traditional IRAs. These exceptions do not apply to 401(k)s, 403(b)s, or other tax-deferred retirement plans:

  1. A first time home purchase – a first-time homebuyer can take up to $10,000 for a down payment (and if your spouse also has an IRA and qualifies as a first-time homebuyer, you can also take up to $10,000 for a purchase).
  2. Buy health insurance: If you have lost your job and collect unemployment for at least 12 consecutive weeks.
  3. Pay higher education expenses – for you, your spouse, children, or grandchildren.
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Exceptions to the 10% Penalty: For 401(k)s and Similar Retirement Plans

Qualified retirement plans, such as 401(k)s, 403(b)s, profit-sharing plans, and Keogh plans, offer a few more options for avoiding the 10% early withdrawal penalty than IRAs, including:

  1. Division of retirement account assets in a divorce under a Qualified Domestic Relations Order (QDRO).
  2. Distributions from government 457(b) plans, except distributions attributable to rollovers from another type of plan or IRA.
  3. Distributions for those age 50 and older for public safety employees separating from service.
  4. Distributions for people age 55 and older in other fields who are separating from service.
  5. Distributions from federal “tiered” plans. A phased retirement option allows employees at or near retirement age to reduce their work hours to part-time, receive benefits, and continue to earn additional funds.

Exceptions that apply to BOTH IRAs and 401(k)s

Some exceptions may apply to both IRAs and retirement plans, and include:

  1. Qualified Reservists: Called to active duty for at least 179 days or for an indefinite period because you are a member of the reserve.
  2. Disability: You must meet the IRS definition of total and permanent disability and have documentation from a physician.
  3. Death of the account holder.
  4. IRS Tax Collection: You would not owe a penalty if the IRS used your account to collect unpaid federal taxes. However, if you make an early withdrawal to pay a tax bill yourself, the exception does not apply and you will be charged a 10% penalty.
  5. Medical expenses (to the extent they exceed 10% of your adjusted gross income).
  6. Adoptions or birth of a child: Up to $5,000 in withdrawals can be penalty-free in the first year.
  7. Substantially Equal Payments (also known as the 72
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