When you take money from an IRA or some other type of tax-favored retirement plan, you’ll usually owe income tax. Before age 59-1/2, you’ll also owe a 10% penalty. Withdraw $20,000 at age 52, for instance, and you’ll owe $2,000 in addition to regular income tax on that $20,000.
There are several exceptions to the penalty. One covers withdrawals from an employer retirement plan such as the Thrift Savings Plan. To avoid the 10% penalty, you must pass these tests:
* The withdrawal must be made after you have separated from service with the employer that maintains the qualified plan.
* The separation must occur during or after the calendar year in which you reach age 55.
Recently, the Seventh Circuit Court Of Appeals upheld a decision against a taxpayer who had rolled money from his employer plan to an IRA, then taken a withdrawal before age 59-1/2. Yes, said the court, you could have withdrawn money from your employer plan, penalty-free, under the age-55 exception. However, once the money went into the IRA, the age-55 exception no longer applied.
Not only did the taxpayer owe the 10% penalty, he also owed a 20% accuracy-related penalty. It pays to know the rules before moving money from an employer’s retirement plan to your IRA.