Preparing Income Taxes - When You Withdraw Retirement Funds "Before Their Time"

There are a variety of qualified savings/retirement fund plans available to taxpayers. Some like traditional and Roth Individual Retirement Arrangements (IRAs) are specifically designed for a taxpayer's retirement years. Others, like a health (or medical) savings accounts (HSA/MSA) and (Coverdell) Education Savings Accounts (ESA) are established for specialized needs such as medical or educational expenses respectively. According to the Internal Revenue Service (IRS), you can contribute or add money to these funds oftentimes on a tax-deferred basis. These qualified contributions typically have some incentivized tax treatment; they either reduce taxable income (like an IRA) or provide a tax credit (like a Saver's Tax Credit). However, there are strict rules regarding the withdrawal or distribution of these same funds. You might receive preferential tax treatment if you make a contributions to these funds but be warned; you could be taxed most likely at your marginally income tax rate AND suffer "early withdrawal" penalties if you drawn down these funds "before their time" or for any reasons other than for those for which they were originally intended.

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IRS Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts is an eight-part tax form that calculates additional taxes on early distribution, distributions from ESAs, IRAs, and HSAs. It also reports additional taxes on excess accumulations in qualified retirement plans when contributions exceeded IRS rules. If you receive, for example, a IRS Form 1099-R and Box 7 shows a code 1 (early distribution without exception) or code 2 (early distribution with exceptions), you might be subject to an additional 10% tax penalty in addition to the income taxes levied on the additional income resulting from the distribution. A Form 1099-INT also reports an early withdrawal penalty amount. For example, if you receive a Form 1099-R with code 1 in Box 7, there are no exceptions to the early withdrawal penalty and you will be charged a 10% penalty that will be computed in Part I of IRS Form 5329. You also file Form 5329 to report regular, or rollover conversions from one type of qualified retirement fund to another.

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Tax and financial implications of what might appear to be simple transfers of "your money" can be VERY complicated especially if they violate IRS rulings and regulations. Consult a practiced tax professional if possible BEFORE you take any financial action. There are ways to avoid penalty fees under qualifying circumstances. If you have received distributions from any of these plans and an IRS Form 1099-R, have a tax professional review your tax returns.

Preparing Income Taxes - When You Withdraw Retirement Funds "Before Their Time"

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