Employers can offer a variety of retirement plan options. You might be covered by a company-sponsored pension plan. Unlike a 401(k) plan or an individual retirement account, you don't make contributions to a pension plan. Your employer makes contributions on your behalf, and the pension fund pays you a regular check once you reach retirement age. Your access to the money in your pension fund prior to retirement is limited. If you are able to take an early withdrawal, you will be subject to a stiff, non-deductible tax penalty.
Employer-Sponsored Pension Plans
Your employer might offer either a defined benefit plan, commonly referred to as a pension plan, or a simplified employee pension individual retirement account plan, commonly referred to as an SEP IRA. Both types of pension plans are fully funded by contributions from the employer. One significant difference between the two types of plans involves ownership of money in the pension plan. Money contributed into a defined benefit plan is controlled by the pension plan. Money contributed into an SEP IRA is controlled by the employee.
Qualified distributions are those that you are permitted to receive by law without incurring a tax penalty. The age a pension plan begins making distributions varies based on perimeters established by law and the individual plan. Most defined benefit pension plans start making qualified distributions once you reach a fixed retirement age, such as 63, although you might be able to take early retirement if you meet minimum service requirements. The Internal Revenue Service considers distributions from a SEP IRA to be the same as distributions from a traditional IRA. In most cases, you have to be at least 59 1/2 years old before you can start taking qualified withdrawals from your SEP IRA. Qualified distributions from both a defined pension plan and a SEP IRA plan are taxed as ordinary income in the year you receive them.
You do not have control over the funds in a defined benefit pension plan, so you cannot take an early withdrawal. You do have control over the money in your SEP IRA, and you can withdraw it at any time for any reason. But because the plan is designed for retirement savings, the IRS considers withdrawals made before you reach age 59 1/2 to be non-qualified. You will have to pay ordinary income on the amount you withdraw, and the IRS will hit you with an additional 10 percent tax penalty.
Early Withdrawal Penalty Deduction
If you take an early withdrawal from certain types of bank savings accounts, such as a certificate of deposit, you might get hit with an early withdrawal penalty. The IRS takes some of the sting out of it by allowing you to deduct the amount of that penalty as an adjustment to your income when you file your federal income tax return. Not so with the early withdrawal tax penalty on retirement accounts, including your SEP IRA. While there are some circumstances that allow you to access the funds in your SEP IRA without incurring the tax penalty, there is no provision for deducting that penalty once it is assessed.
- IRS: Retirement Plans FAQs Regarding IRAs
- IRS: Form 1040
- IRS: Publication 575 Pension and Annuity Income
- IRS: Topic 558 - Tax on Early Distributions from Retirement Plans, Other Than IRAs
- Department of Labor: What You Should Know About Your Retirement Plan
- Beacon Capital Management Advisors: SEP IRA for a Business Owner with Employees
- IRS: Publication 560 Retirement Plans for Small Business
- IRS: Publication 590 Simplified Employee Pension (SEP)
- IRS: Retirement Plans FAQs regarding SEPs