Early Withdrawal from Retirement Account

Retirement accounts such as IRA’s, 401k’s and company sponsored retirement accounts receive special tax treatment because the money is not supposed to be used by the owner of the account until she reaches a specified age, usually over 62 or over 65.  The thought is that she can put aside that money now tax free into the restricted account while she is working and is in a higher tax bracket.  Then, when

 

she turns 65 or later, she can withdraw the money and pay taxes on it when she is presumably in a lower tax bracket.  Therefore, when a person withdraws money from a 401-K plan or any retirement plan before he is 62, he is assessed a penalty for early withdrawal in addition to having to pay income tax on the money withdrawn.  This creates a double tax liability for all early withdrawals.  This is the primary reason one should never dip into a retirement plan early unless it is a dire emergency.   If you absolutely have to withdraw money from your plan, you can and should request that at least 25% to 30% of the amount withdrawn be withheld by the plan administrator at the time of withdrawal and paid to the IRS as estimated tax.  Your administrator can help you determine the amount to be withheld. If you do this, you will not have such a huge liability at tax time.  However, if you neglect to do this and have a large tax bill at tax time, you can usually set up an Installment Agreement, or perhaps an Offer In Compromise, depending on the amount owed.  You can also try to abate the penalties involved, due to your ignorance of the tax problem and how the early withdrawal process works.  It is always best to get a professional involved when trying to make settlements with the IRS.