IRS Tax Tip 2013-35

Taking money out early from your retirement plan can cost you an extra 10 percent in taxes. Here are five things you should know about early withdrawals from retirement plans.

• An early withdrawal normally means taking money from your plan, such as a 401(k), before you reach age 59½.

• You must report the amount you withdrew from your retirement plan to the IRS as taxable income. You may have to pay an additional 10 percent tax on your withdrawal.

• The additional 10 percent tax normally does not apply to nontaxable withdrawals. Nontaxable withdrawals include withdrawals of your cost in participating in the plan. Your cost includes contributions that you paid tax on before you put them into the plan.

• If you transfer a withdrawal from one qualified retirement plan to another (or an IRA) within 60 days, the transfer is a rollover. Rollovers are not subject to income tax. The added 10 percent tax also does not apply to a rollover.

• There are several other exceptions to the additional 10 percent tax. These include withdrawals if you have certain medical expenses, if you are disabled or are a First-Time Home Buyer ($10,000). Additionally, exceptions from qualified plans include withdrawals after separation from service if annuitized or after age 55 (50 for public safety). Some of the exceptions for qualified plans are different from the rules for IRAs.

For more information on early distributions from retirement plans, see IRS Publication 575, Pension and Annuity Income. Also, see IRS Publication 590, Individual Retirement Arrangements (IRAs). Both publications are available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).

Additional IRS Resources:

Publication 575, Pension and Annuity Income

Publication 590, Individual Retirement Arrangements (IRAs)

Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts

http://www.irs.gov/uac/Newsroom/Tax-Rules-on-Early-Withdrawals-from-Retirement-Plans

Although half of Americans consider retirement a top priority, 58% do not have a formal retirement income and savings plan, according to a report released by Deloitte.

Harris Interactive surveyed nearly 4,500 Americans over 26 on behalf of Deloitte Center for Financial Services and found that although just 30% say they feel “very secure” in their retirement prospects, those with a plan were four times more likely to feel secure. What’s troubling, though, is that many people are convinced that no matter how much they save, it won’t be enough.

“People used to think about retirement as a straight-line plan to a lump sum,” Ed Tracy, one of the authors of the report, told AdvisorOne on Friday. “That’s changed, particularly since the financial crisis; the way people think about retirement is fundamentally changing.”

Investors are facing more short-term challenges, Tracy said. “Life is more turbulent in terms of employment, education—the cost of college isn’t going down—health care, basic short-term expenses. It got to the point where a lot of people are pessimistic.”

To combat that pessimism, “wealth managers have to recognize that viewpoint has changed a bit and pursue short-term, medium-term and long-term strategies.

The influence of an advisor is undeniable. Two-thirds of respondents who work with a professional advisor had a retirement plan compared with 28% of respondents who don’t have an advisor.

Deloitte identified five potential barriers that may be keeping respondents from adequately preparing for retirement.

First, they may be struggling to find a place for it among their other financial priorities. Respondents said the No. 1 reason they didn’t have a financial plan was because they had other, more important priorities.

Furthermore, the retirement industry may be failing these consumers. Sixty percent said that in the past two years, they’ve had no interaction with any financial institutions about their retirement needs. Even when financial institutions do communicate with consumers, according to the report, they often don’t help them integrate their retirement planning needs into their larger financial plan.

A third barrier is consumers’ lack of understanding about financial products. Nearly 40% don’t know about or understand annuities. Many are simply unaware of the number of options available to them.

That sense of mistrust and disappoint gave rise to the fifth barrier Deloitte identified: the DIY investor. Many respondents said they simply didn’t need any help with planning. About 40% said they preferred to manage their own portfolio.

Trust, or a lack of it, was one of the top reasons those DIY investors gave for wanting to take on their financial planning by themselves, Tracy said. While it may seem like investors who are trying to plan on their own are at least a little better off than those who aren’t planning at all, the report found just 17% of respondents are managing their portfolio on their own and also have a retirement plan in place.

Tracy noted, though, that just because there’s a large segment that doesn’t have a plan, that doesn’t mean there isn’t a lot of activity in terms of investments. “Wealth managers need to rethink what they need to be providing,” he said.

Another barrier is a holdover from the recession. Respondents had a remarkably low level of trust for financial institutions in general. Just 20% said they had a high degree of trust for financial institutions of any type.

“After the crisis, investors started looking closer at their portfolios and that hasn’t ebbed,” Tracy said. “Folks are leery about proprietary products and assets allocations that don’t tie to their individual goals.” Tracy said that “intertwined with that mistrust” is investors’ disappointment with a lack of tailored advice.