How to Reduce Penalty on Early IRA Withdrawal

If you want to take an early withdrawal from your individual retirement account, the Internal Revenue Service won't stop you. However, the IRS does offer some discouragement with a 10 percent early withdrawal tax penalty on the taxable portion of most non-qualified distributions. You can weasel your way out of the some or all of the penalty if you qualify for an exception.

Step 1

Figure the taxable portion of your withdrawal on Form 8606. If you're withdrawing from a traditional IRA and haven't made any nondeductible contributions, it's all taxable. Use the form if you've made nondeductible contributions to the traditional IRA, or you're taking money from a Roth IRA. Traditional IRA distributions get split between nondeductible contributions, which come out tax-free, and the remainder of your account, which gets taxed.

Step 2

Write the taxable portion of the distribution on line 1 of Form 5329 and the exception amount on line 2. Some penalty exceptions, such as suffering a permanent disability, exempt your distribution no matter how much you take out. Others, like the exception for higher education, only apply to the amount of qualified expenses you paid during the year.

Step 3

Write the code for the early withdrawal exception next to line 2 on Form 5329. The codes are in the IRS instructions for Form 5329. For example, if you have medical expenses beyond the required adjusted gross income threshold, use code "05." If you're taking a qualified reservist distribution, use code "11." If you have multiple exceptions, use code "12."

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