Key takeaways

  • The IRS doesn’t actually call this a penalty; the official term is the additional 10 percent tax, which is added to ordinary income tax when retirement assets are withdrawn before age 59½. Most qualifying retirement plans fall under it, including Traditional IRAs, SEP IRAs, SIMPLE IRAs, 401(k)s, and 403(b)s. 
  • Roth IRA contributions are exempt from these restrictions. Because they are made with after-tax dollars, investors can withdraw their principal contributions at any time without incurring income tax or early-withdrawal penalties. Note that investment earnings are subject to different distribution rules, which are detailed below.
  • The IRS keeps a list of exceptions that waive the 10 percent penalty without affecting the income tax. Qualifying for one doesn’t reduce income tax owed. The two obligations are structurally separate.
  • While tapping into retirement accounts early without a penalty is possible, doing so requires sticking to a strict, unchanging payment schedule. Altering or stopping these withdrawals too soon triggers retroactive IRS penalties and interest on all previous distributions, which also require proactive paperwork to properly claim the exemption.

Before age 59½, pulling money from a retirement account triggers two tax obligations that most people treat as one. The 10 percent early withdrawal penalty, formally the additional 10 percent tax, is not a surcharge added to the income tax bill. It’s a separate calculation on the same distributed amount. Taking $20,000 early in a high-income year could mean ordinary income tax on the full $20,000, plus an additional $2,000 in penalties. Neither figure offsets the other.

Some exceptions can eliminate the penalty portion, but won’t ultimately change the income tax calculation. 

The age 59½ rule

The IRS classifies the 10% early withdrawal charge as an additional tax, not a penalty, which is a crucial distinction. While standard tax penalties can sometimes be waived for “reasonable cause” or a good excuse, this structural tax applies automatically to any pre-age-59½ distribution from a qualified retirement plan.

While specific legal exceptions exist (such as structured 72(t) payments or qualifying medical events) the IRS will not waive the tax based on personal circumstances or financial hardships that fall outside those strict, predefined rules.

The distributed amount is also included in gross income for that year, so ordinary income tax is calculated simultaneously. Two separate calculations on the same withdrawal.

Roth IRAs operate on a different logic. Contributions are made with after-tax dollars, so they can be withdrawn at any time without penalty or income tax. Earnings, however, are subject to more complex criteria. To pull earnings out completely tax- and penalty-free, the distribution must be taken after age 59½ and after a five-year holding requirement is satisfied. If earnings are withdrawn before age 59½, they are generally subject to both ordinary income tax and the 10 percent additional tax. (Note that the five-year clock starts January 1 of the year the first contribution was made, not the actual date of the deposit).

Graphic by Kate Farley

Common exceptions

Still, some exceptions can waive the penalty. Each has specific IRS requirements. Not every difficult financial situation automatically qualifies, including ones where the hardship appears to fit the spirit of the exception.

1. Disability

Total and permanent disability qualifies under both IRAs and qualified retirement plans. Specifically, the inability to engage in any substantial gainful activity because of a medically determinable physical or mental condition that meets those criteria, according to IRS Publication 590-B.

2. Death

Distributions to a beneficiary after the account owner dies are exempt. The beneficiary’s age doesn’t factor into it.

3. Unreimbursed medical expenses

Distributions used to pay unreimbursed medical expenses exceeding 7.5 percent of adjusted gross income qualify. To qualify for the medical expense penalty exception, the medical expenses must be paid in the same calendar year as the retirement distribution. The IRS does not allow a mismatch of tax years for this specific exception. Only the amount above the 7.5 percent floor qualifies, not the total amount spent.

4. Health insurance premiums while out of work

IRA account holders who received unemployment compensation for at least 12 consecutive weeks and use IRA distributions to pay health insurance premiums qualify. IRA distributions only, not 401(k) plans.

5. Higher education expenses

IRA distributions of qualifying higher education expenses, including tuition, fees, books, supplies, and, where applicable, room and board, are exempt for the account holder, spouse, children, or grandchildren. IRAs only, not employer-sponsored plans.

6. First-time home purchase

For a first-time home purchase, up to $10,000 in lifetime withdrawals may be made penalty-free from an IRA. The IRS defines “first-time” as not having owned a home in the prior two years, which applies to both the account holder and their spouse. IRA only.

7. Birth or adoption

The SECURE Act created an exception for distributions up to $5,000 per child within one year of birth or finalization of legal adoption. Covers both IRAs and qualified employer plans, the IRS says.

8. Terminal illness

Added by the SECURE 2.0 Act and effective for distributions made on or after December 29, 2022. A physician must certify that the account holder has an illness or physical condition reasonably expected to result in death within 84 months (7 years) or less from the date of the certification.

9. Separation from service at 55

Employees who separate from their employer through retirement, resignation, layoff, or termination at age 55 or older (age 50 for public safety workers) may take distributions from that employer’s plan without penalty. The age that matters is the age at separation, not the age at distribution. Not IRAs. Not prior employer plans.

Rule 72(t): Substantially equal periodic payments

Rule 72(t), also called SEPP for Substantially Equal Periodic Payments, creates a path to penalty-free withdrawals at any age. The IRS treats it as a legitimate distribution strategy because the payment schedule functions more like a systematic drawdown than an ad hoc withdrawal. Distributions must be taken at least once a year. One of three IRS-approved methods is used: 

  1. Required minimum distribution: This method divides the retirement account balance each year by the account owner’s life expectancy, determined by IRS actuarial tables. Because the account balance fluctuates with market performance and life expectancy decreases annually, the payout amount changes every year. While this is typically the simplest method to calculate, it generally results in the lowest initial annual distribution of the three options.
  2. Fixed amortization: This method calculates a fixed annual payment by amortizing the initial account balance over the account owner’s life expectancy using an IRS-approved interest rate. This functions similarly to a mortgage in reverse. The calculation is performed only once at the inception of the plan, meaning the annual payment remains exactly the same every year for the duration of the schedule. This method typically yields a higher initial payout than the RMD method.
  3. Fixed annuitization: This method determines a fixed annual payment by dividing the account balance by an annuity factor provided by the IRS, which incorporates mortality tables and an approved interest rate. Similar to the amortization method, this calculation is locked in at the beginning, ensuring the annual payment remains identical every year. It generally results in a higher annual payout, though the mathematical formula is slightly more complex.

Each one produces a different payment amount, which is worth knowing before picking. The method chosen at inception is binding. Switching before the required period ends triggers the retroactive penalty. Payments must continue for the longer of five years or until age 59½ — IRS Publication 590-B.

The retroactive liability is what most people underestimate. If the schedule is modified before the required period ends, the 10 percent penalty applies to every prior distribution plus interest from the date each payment was received. Start SEPP at 45, modify at 48, and the penalty runs on every payment taken since 45, including three years of accumulated interest. The exposure runs backward, not forward.

Go Further: IRS Notice 2022-06 and Publication 590-B at irs.gov/publications/p590b contain the IRS’s current guidance on all three Rule 72(t) calculation methods, including updated life expectancy tables and interest rate ceilings. Professional guidance before starting a SEPP arrangement is highly recommended.

How a financial advisor can help

A qualified financial advisor or tax professional can help account holders work through the full picture before an early distribution is taken. The immediate tax bill is only part of it. Removing funds from a tax-deferred account eliminates years of compounding, and that cost often exceeds the penalty itself over a long enough horizon. 

A financial advisor can model the after-tax cost against alternatives including a 401(k) loan, a Roth contribution withdrawal, or a SEPP arrangement, and show how each one interacts with the household’s tax situation in the same year. For Rule 72(t) specifically, modeling all three calculation methods before committing matters because the method determines both the payment amount and the flexibility that remains if circumstances change.

FAQs

Does the 10 percent penalty apply to Roth IRA distributions? 

It depends entirely on what is being withdrawn and the account holder’s age. Original contributions can be withdrawn at any time, completely tax- and penalty-free. Investment earnings are different.

If under age 59½: Withdrawing earnings will generally trigger both ordinary income tax and the 10 percent additional tax unless a specific exception applies.

If age 59½ or older: The 10 percent early withdrawal penalty disappears completely. However, if the account has not been open for at least five tax years, those earnings will still be subject to ordinary income tax. Once the five-year clock and the age 59½ threshold are both met, earnings become completely tax- and penalty-free — IRS Publication 590-B.

What is Form 5329, and when does it need to be filed? 

Form 5329 is how the additional 10 percent tax on early distributions gets reported, or how an exception gets claimed. If Box 7 of Form 1099-R already shows the applicable exception code, the form may not be required. If it doesn’t, Form 5329 is the only way to claim it. Skip it when required, and the IRS may assess the full 10 percent tax as if no exception exists — IRS Topic 557.

Do 457(b) government plan distributions incur the penalty? 

No, and the reason is structural. Government 457(b) plans were set up under a different section of the tax code. The 10 percent early withdrawal penalty simply doesn’t apply, regardless of the account holder’s age, the IRS confirms. Ordinary income tax applies to distributions. The additional 10 percent tax is not part of that calculation.

Glossary

  • Additional 10% tax. What the IRS calls this charge — officially the additional 10 percent tax, not a penalty. It hits early distributions from qualified retirement plans and IRAs, in addition to ordinary income tax. Account holders under 59½ are subject to it.
  • Early distribution. The IRS term for any withdrawal from a traditional IRA, SEP IRA, SIMPLE IRA, 401(k), 403(b), or other qualifying plan before the account holder turns 59½. Age is what triggers it. The reason for the withdrawal doesn’t factor in.
  • Form 5329. Filed with the annual federal return. How the additional 10 percent tax on early distributions gets reported — or how an exception gets claimed. No exception code on the 1099-R? This form is the only way to apply it.
  • Qualified domestic relations order (QDRO). A court order that moves retirement plan benefits to an alternate payee, usually a former spouse, as part of a divorce. Distributions from a qualified plan under a QDRO don’t carry the 10 percent penalty. That pass doesn’t extend to IRA distributions, though.
  • Rule 72(t). An IRS code provision that allows account holders to take penalty-free early withdrawals in substantially equal periodic payments using one of three IRS-approved methods. Payments run for at least five years or until age 59½, whichever is longer.
  • Substantially equal periodic payments (SEPP). Regular retirement account distributions set up to qualify under the Rule 72(t) exception. The method picked at the start stays locked in. Change it before the required period is up and the retroactive penalty applies to everything already paid out.

Sources

Disclaimer: Steady Retire and MediaFeed are providers of educational content and information. This article is intended for informational and illustrative purposes only and does not constitute financial, legal, tax, or investment advice. The information provided does not create a professional-client relationship and should not be used as a substitute for consultation with a qualified financial advisor, tax professional, or attorney. While we strive to provide accurate and up-to-date information, rules and regulations regarding retirement are subject to change. Always consult with a certified professional regarding your specific financial situation.