If you take money out of a tax-deferred retirement plan before age 59-1/2, you will owe a 10% penalty tax as well as income tax. However, the following exceptions apply to all types of plans:
Death. If you inherit a retirement account you won’t face the 10% penalty, no matter how old you are.
Disability. The 10% penalty doesn’t apply if you can’t work. Generally, you should be receiving a disability check from Social Security or from a disability insurance policy. Attach an explanation to your tax return, explaining that you are receiving disability benefits so the 10% penalty should not apply.
Medical bills. The 10% penalty won’t apply to money spent for medical expenses in excess of 7.5% of your adjusted gross income (AGI). Suppose you have AGI of $60,000 in 2001 and medical expenses of $10,000. Deductible medical expenses start at $4,500 in your case: 7.5% of $60,000. If your medical bills are $10,000 you are $5,500 over the threshold so you could withdraw $5,500 from your retirement plan, penalty-free.
Substantially equal periodic payments (SEPP). You can avoid the 10% penalty by taking SEPPs be based on your life expectancy. SEPPs must continue for at least five years or until age 59-1/2, whichever comes later.
