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Ten Percent Penalty

As a general rule, a 10 percent penalty applies for a distribution before age 59-1/2. A higher penalty (25 percent) applies for taking a distribution from a SIMPLE plan within the first two years of participation. Your 1099-R should show a distribution code of "S" in Box 7 if this 25 percent rate applies.

Exceptions for all plan types. The 10 percent penalty does not apply to qualified plans or IRAs if the distributions are:

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If you want to take advantage of this last exception, talk to your financial planner about setting up a series of equal payments. There are a number of ways to calculate the payments that are acceptable to the IRS, and your choice among them should depend on things like the size of your lump sum and whether you need more or less cash from the plan each year.

However, once you set up a method, you must stick with it. If you deviate from your chosen method before the end of five years or your attainment of age 59-1/2 (whichever takes longer), for any reason other than death or disability, you'll generally have to pay a recapture tax, plus interest, on all distributions received thus far.

Exceptions for IRAs. See also our discussion on premature distributions from IRAs and some special exceptions that can apply.

Exceptions for qualified retirement plans. The 10 percent penalty does not apply to qualified plans if the distributions are:

Exceptions for nonqualified annuities. The 10 percent penalty does not apply to payments from deferred annuity contracts not purchased by qualified employer plans (i.e., deferred annuities you purchased from a commercial provider) if the payments are:

Reporting the excise tax. If you owe only the extra 10 percent tax on premature distributions, and distribution code 1 is shown in Box 7 of your 1099-R, you can simply enter 10 percent of your taxable distribution on Line 58 of Form 1040. Write "no" on the dotted line next to Line 58 to show that you don't have to file Form 5329.

Otherwise, you must complete Form 5329, Additional Taxes on Qualified Plans (including IRAs) and Other Tax-Favored Accounts and attach it to your tax return. This form is also required if you meet an exception to the tax but your 1099-R form does not indicate a code for an exception in Box 7, or the code is incorrect.


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