When you take money out of your 401(k) before you are 59 1/2 years old, you must pay a 10 percent additional tax penalty on your distribution unless you roll the funds into another qualifying retirement plan within 60 days. Other exceptions include distributions for medical expenses exceeding 7.5 percent of your adjusted gross income, those taken after suffering a permanent disability, distributions to an ex-spouse under a qualified domestic relations order, and distributions made due to an IRA levy on the plan.
Enter the total amount of your 401(k) distribution on line 1 of Form 5329. For example, if you took out $10,000, enter "10,000" on line 1.
Write the code for your exemption in the box next to line 2. The codes are listed on page 3 of the Form 5329 instructions. For example, if you suffered a permanent disability, you would enter code "03" next to line 2. If you used the money for medical expenses in excess of 7.5 percent of your adjusted gross income, you would use code "05."
Enter the amount of your distribution that qualifies for the exemption. You may claim an exemption even if your exemption does not cover the entire amount. For example, if you are permanently disabled, the entire amount is exempted. However, if you took a distribution of $8,000 but your medical expenses that exceed 7.5 percent of your adjusted gross income is only $6,000, you may still exempt all but $2,000 of the distribution from the penalty.
Subtract the amount of your exemption from the amount of your distribution to determine if any of your distribution is subject to the penalty. If your exemption covers the entire distribution, you owe no penalty. However, if your exemption is smaller than your distribution, the remainder is subject to the 10 percent penalty. For example, if $2,000 of your distribution is not exempt, the taxpayer would owe a $200 penalty.
File your taxes using Form 1040 and attach Form 5329. You must file with Form 1040 if you are claiming an exemption from the penalty. When the IRS receives your income tax return with Form 5329 attached, the code informs the IRS why the penalty is exempted.
Items you will need
- Form 5329
- Form 1040
- Permission to take a hardship distribution from your 401 (k) plan does not necessarily mean you qualify for an exemption from the penalty. For example, many 401(k) plans permit hardship distributions for making mortgage payments to avoid foreclosure, but there is no exemption from the penalty for such distributions.
- IRAs exempt distributions taken for higher education expenses and up to $10,000 for the purchase of a first home from the penalty. These exceptions do not apply to early distributions from a 401(k) plan.
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