Early Lump-Sum Withdrawal From a Pension Plan

When you’re faced with a financial emergency, it can be hard to know where to turn. Loans can be time consuming and difficult to obtain if you don’t have good credit. Asking family or friends for money can be awkward and embarrassing.

It may be tempting to take a lump-sum withdrawal from a pension plan. After all, the money is just sitting there, waiting for you to retire. An early retirement plan withdrawal can have serious tax consequences, though. It’s important to keep those consequences in mind as you decide whether or not to take an early distribution from your retirement plan.

An early distribution from a 401(k) or other qualified retirement plan is typically subject to income taxes. In addition to income taxes, though, you may have to pay a 10 percent penalty on your withdrawal.

For example, if you withdraw $20,000 from your qualified retirement account and you are in the 28 percent income tax bracket, you will pay $5,600 in income taxes on the distribution. You will also pay $1,000 as an early withdrawal penalty. This leaves you with $13,400 of your original distribution.

In the case of most distributions, you will receive a Form 1099-R from your retirement plan to include with your tax return when you send it to the IRS. When you are preparing your taxes, you will enter the 10 percent penalty amount on the appropriate line of your Form 1040 unless you qualify for one of the exceptions.

In certain situations, you may be able to qualify for an exception to the pension early withdrawal penalty. If you are totally and permanently disabled and unable to work, you can qualify for a penalty-free early withdrawal. You can also qualify for an early withdrawal with no penalties if you have medical expenses that exceed 10 percent of your adjusted gross income.

There are also exceptions for withdrawals made by military reservists who are called to active duty. If you leave your employer after you reach age 55 (or age 50 if you work in some state government positions) you can also make an early withdrawal without a penalty.

You can also opt to make your withdrawal as a series of equal payments over your lifetime instead of a lump sum. This means that the plan uses IRS rules to determine about how much you can receive on a regular basis for at least five years or until you are at least age 59 ½, whichever is last. For qualified plans, you have to leave your employer to get these payments. If you make changes to the equal payments, you will have to pay the early withdrawal penalty.

The early withdrawal penalty for 2018 taxes, which are filed in 2019, is 10 percent. What changes from year to year, though, are the tax brackets. For 2018, there are seven brackets. The tax brackets start at 10 percent for single filers who make up to $9,525 in total income, heads of household who make up to $13,600 in 2018 and married couples who are filing jointly with income up to $19,050.

If you make an early withdrawal from a pension plan, you may get bumped to a higher tax bracket. If you are filing as single and your income from your work is $35,000, you are in the 12 percent tax bracket. If you withdraw $5,000 early from a pension plan, your income for the year will be $40,000, which bumps you into the 22 percent bracket. This means that any income above $38,700 will be taxed at a 22 percent tax rate.

The early withdrawal penalty for 2017 taxes, which are filed in 2018, is also 10 percent. There are seven income tax brackets, with the lowest bracket at a 10 percent tax rate. The highest bracket is at a 39.6 percent tax rate. If you are filing as single and you made $35,000 from work, your tax rate is 15 percent. If you took a $5,000 early withdrawal, you would be bumped up to the next bracket, which is 25 percent. In addition to the tax penalty, you would pay a tax rate of 25 percent for any income above $37,950.