Retirement Plans Are Not Rainy Day Funds: Early Distributions = Stiff Penalties!


Qualified retirement plans are intended for retirement savings, not rainy day funds.  Hence, if a qualified plan participant (or IRA owner) takes distributions from the plan (or IRA) prior to reaching age 59 ½, pursuant to Section 72(t) of the Internal Revenue Code, the taxable part of those distributions is subject to a 10% penalty.  There are narrow exceptions to the penalty, for example, if the participant is unable to earn money due to disability and requires early distributions to survive; or if the participant is retired and over the age of 55 and takes payments over his or her lifetime, the penalty will not apply.  The IRS, Tax Court, and other Federal Courts have strictly enforced the penalty.  By that I mean that taxpayers have been unsuccessful in their attempts to avoid the penalty for reasons such as financial hardship (lost job, lost job of spouse, increased expenses) and other reasons that the statute does not expressly list.

Why have taxpayers arguing financial hardship been so unsuccessful?  Think of Congress’s goals associated with qualified plans, namely, to secure individual retirement plans and increase retirement savings.  If participants were free to take distributions prior to retirement age, the qualified plans would not be meeting the overarching goal of encouraging employees to save for retirement.  Rather, instead of qualified plans being retirement accounts, they would be rainy day accounts, which is not the goal of qualified plans.  Accordingly, Congress put the penalty in place as a deterrent from participants shrinking their own retirement accounts.  Thus, the strict application of the penalty is recognition by the IRS and Courts of the goals associated with qualified plans.

Learning laws by understanding their purpose helped me get ahead in law school.  More importantly, at Altman & Associates, our commitment to knowing and understanding complex laws enables us to advise our clients strategically and with certainty.

–  Michael Wolsh, Esq.

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