To discourage the use of pension 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 or deferred annuity contract before reaching age 59 1/2. The term "qualified retirement plan" means:

• A qualified employee plan such as a 401(k) plan,
• A qualified employee annuity plan,
• A tax–sheltered annuity plan for employees of public schools or tax–exempt organizations,
• An IRA other than an education IRA, or
• If you have an early distribution from a SIMPLE IRA plan within the first 2 years of participation in the plan, the additional tax is 25%.

Distributions that are not taxable such as distributions that you roll over to another qualified retirement plan are not subject to this 10% tax. For more information on rollovers, refer to Tax Topic 413.

There are certain exceptions to this penalty. The following five exceptions apply to distributions from any qualified retirement plan:

• 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 the life expectancy of the owner or life expectancies of the owner and the beneficiary. If these distributions are from a qualified plan other than an IRA, 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 your deductible medical expenses, that is, the amount of your medical expenses that is more than 7.5% of your adjusted gross income. You do not have to itemize to meet this exception. For more information on medical expenses, refer to Tax Topic 502.
• Distributions made due to an IRS levy of the plan.

The following additional exceptions apply only to distributions from a qualified retirement plan other than an IRA:

• Distributions made to you after you separated from service with your employer, if the separation occurred in or after the year you reached age 55,
• Distributions made to an alternate payee under a qualified domestic relations order, and
• Distributions of dividends from employee stock ownership plans.

The following exceptions apply only to distributions from IRAs:

• Distributions equal to or less than your qualified higher education expenses,
• Distributions made to pay for a first–time home purchase, and
• Distributions made to pay health insurance premiums if you are unemployed.

Refer to Tax Topic 557 for information on the tax on early distributions from IRAs. For more information, refer to Publication 575 (PDF), Pension and Annuity Income.

The 10% tax is reported on Form 1040 (PDF), line 59. You must also file Form 5329 (PDF) if:

• Your distribution is subject to the tax, and distribution code "1" is not shown in Box 7 of Form 1099R (PDF), or
• One of the exceptions applies but Box 7 does not show a distribution code of "2", "3", or "4". On the other hand, you do not need to file Form 5329 if your distribution is subject to the tax and Box 7 shows a distribution code of "1". In this case enter the 10% tax on line 55 of Form 1040 and write "no" on the dotted line next to line 55.

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, refer to Tax Topic 355, or Publication 505 (PDF), Tax Withholding and Estimated Tax.

Tax Topics & FAQs | 2002 Tax Year Archives | Tax Help Archives | Home