Uncle Sam benevolently encourages retirement savings with tax-advantaged pension plans, including 401(k) and 403(b) plans. However, the benevolence only extends as long as you use the money for retirement savings. When you take early distributions, the IRS usually hits you with additional taxes to dissuade you from undercutting your retirement savings.
Permissible Distribution Times
In most cases, you can only cash out money from a pension after you turn 59 1/2 years old. However, exceptions apply if you leave the job, become permanently disabled, or have a severe financial need. When you take distributions before age 59 1/2, you usually have to pay not only the income taxes on the distribution, but also an extra 10 percent tax because you're taking a non-qualified distribution. Potential exceptions to the additional 10 percent tax include medical expenses exceeding 7.5 percent of your adjusted gross income, IRS levies on the pension, and when the distributions are part of a series of substantially level payments.
Some pensions might permit you to take a hardship distribution. Hardship distributions are permissible under IRS rules when the need is immediate and significant and you need the money from the pension to satisfy the financial need. For example, medical costs, college tuition, funeral costs or repairing damage to your home cold qualify as hardships. However, unless your hardship falls under a specific exemption from the additional tax on early distributions, you still owe the extra 10 percent tax on the distribution.
A qualified domestic relations order, or QDRO, is used in a divorce to divide pension and retirement assets between the spouses. For example, if one spouse has a pension worth $250,000, the QDRO might order the plan to distribute $125,000 to the other spouse. Because the distribution is due to a QDRO, the distribution is taxable to the spouse who receives the money and is not subject to the additional tax on early withdrawals. However, a QDRO cannot force a plan to do anything that it normally wouldn't do under the plan rules. For example, if a plan does not permit early distributions under any circumstances, a QDRO cannot force the plan to cash out a pension early.
If you moved on to bigger and better things from an old job, you probably want to take your pension with you. However, you probably don't want to pay the additional taxes, nor do you need the money. Consider rolling the money over into either your new employer's pension plan, if it accepts rollovers, or into a traditional IRA. Either of these options lets you avoid paying an income tax on the distribution and continue to reap the benefits of a tax-deferred account.
- Jupiterimages/Photos.com/Getty Images
- How to Calculate Net Change in Cash From a Cash Flow Statement
- The Disadvantage & Advantage of Short-Term Financing
- Can a Homeowner Sue the HOA for Not Following the CC&R;'s Rules & Regulations?
- The Tax Benefits of Gifts Vs. Donations
- Do You Have to Pay After a Repossession?
- What Can I Do If My Car Is Repossessed & I Can't Pay the Difference After Auction?
- How Much Tax Do You Pay on a Cashed Out 403(b)?