To discourage the use of tax deferred qualified retirement funds for purposes other than normal retirement, the law imposes an additional 10% tax on certain early distributions of these funds. Early distributions are those you receive from a qualified retirement plan before reaching age 59½. The term "qualified retirement plan" means:

• A qualified employee retirement plan such as a 401(k),
• A qualified annuity plan,
• A tax-sheltered annuity plan for employees of public schools or tax-exempt organizations, such as a 403(b) plan
• An individual retirement plan, or IRA.

Distributions that you roll over to another qualified retirement plan are not subject to this 10% tax. For more information on rollovers, select Topic 413.

There are certain exceptions to this penalty. Four of these exceptions apply to distributions from any type of qualified retirement plan. For 1998, they are:

• Distributions made to your beneficiary or estate on or after your death,
• Distributions made because you are totally and permanently disabled,
• Distributions made as part of a series of substantially equal periodic payments over your life or life expectancy. If these distributions are from a qualified employee plan, you must separate from service with this employer before the payments begin for this exception to apply.
• Distributions that are equal to or less than the amount of your deductible medical expenses, that is the amount of your medical expenses that are more than 7.5% of your adjusted gross income. You do not have to itemize to meet this exception.

Beginning in 1997 for IRAs only, distributions up to the amount you paid for medical insurance for you, your spouse, and your dependents due to loss of employment. Refer to Publication 590 for conditions that must be met for the 10% tax not to apply. For more information on medical expenses, select Topic 502.

Additional exceptions apply to distributions from a qualified employee retirement or annuity plan. For information on these exceptions, order Publication 575, Pension and Annuity Income. For more information on IRA distributions, order Publication 590, Individual Retirement Arrangements (IRAs).

The 10% tax is reported on Form 5329. However, you do not have to file Form 5329 if your Form 1099-R shows a distribution code "1" in box 7. In this instance, you need only enter the 10% tax on line 50 of your Form 1040. If you meet one of the exceptions to the tax, and your Form 1099-R does not have a distribution code "2", "3", or "4" in box 7, or if the code shown is incorrect, you must file Form 5329 to claim the exception.

Distributions from a qualified retirement plan are subject to federal income tax withholding; however, if your distribution is subject to the 10% additional tax, your withholding may not be enough. You may have to make estimated tax payments. For more information on estimated tax payments, select Topic 355, or order Publication 505, Tax Withholding and Estimated Tax. Forms and publications can be downloaded from this site, or ordered by calling 1-800-829-3676.

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