9.5 Early Withdrawal Penalties & Exceptions
Key Takeaways
- Standard 10% early withdrawal penalty applies to distributions before age 59-1/2; SIMPLE IRA penalty is 25% within first 2 years of participation
- Exceptions apply to both IRAs and employer plans: death, disability, SEPP/72(t), medical expenses exceeding 7.5% AGI, IRS levy, and qualified reservist distributions
- IRA-only exceptions: first-time home purchase ($10,000 lifetime), higher education expenses, and health insurance premiums while unemployed
- Employer plan-only exceptions: separation from service at age 55+ (or 50 for public safety; age 50 or 25-years-of-service for private-sector firefighters), QDRO distributions, and 457(b) governmental plan distributions
- SECURE 2.0 exceptions (effective 2024-2025): emergency personal expense ($1,000/year), domestic abuse victim (lesser of $10,000 or 50%), terminal illness (unlimited), and federally declared disaster distributions ($22,000 per disaster)
When taxpayers withdraw funds from retirement accounts before reaching age 59-1/2, they generally face a 10% additional tax (commonly called the "early withdrawal penalty") on top of regular income tax. Internal Revenue Code Section 72(t) provides numerous exceptions to this penalty, and the SECURE Act 2.0 (effective 2024 forward) added several new ones. Understanding these rules for the 2025 tax year is essential for EA exam success.
The Basic 10% Early Withdrawal Penalty
General Rule
Distributions from qualified retirement plans, IRAs, and other tax-favored retirement accounts taken before age 59-1/2 are subject to a 10% additional tax under IRC § 72(t).
| Account Type | Standard Penalty | Notes |
|---|---|---|
| Traditional IRA | 10% | Plus ordinary income tax on full amount |
| Roth IRA (earnings only) | 10% | Contributions always tax/penalty-free |
| 401(k) / 403(b) / TSP | 10% | Plus ordinary income tax |
| SEP-IRA | 10% | Same rules as Traditional IRA |
| SIMPLE IRA | 10% or 25% | 25% within first 2 years |
Important: The Penalty is ADDITIONAL
The 10% penalty is in addition to regular income tax. For example, in 2025:
- $10,000 early withdrawal from Traditional IRA
- Regular income tax (22% bracket): $2,200
- 10% early withdrawal penalty: $1,000
- Total tax: $3,200 (32% effective rate)
SIMPLE IRA: The 25% Penalty Rule
Critical EA Exam Topic: SIMPLE IRAs have an enhanced penalty during the first two years of participation.
The 2-Year Rule
| Timing of Withdrawal | Penalty (if under 59-1/2) |
|---|---|
| Within first 2 years of participation | 25% early withdrawal penalty |
| After 2 years | Standard 10% early withdrawal penalty |
When Does the 2-Year Period Start?
The 2-year period begins on the date of the employee's first contribution to the SIMPLE IRA (whether employer or employee contribution).
2-Year Restriction on Rollovers/Transfers
During the first 2 years:
- SIMPLE-to-SIMPLE transfers: Allowed without penalty
- SIMPLE to Traditional IRA, 401(k), or SEP: Treated as a distribution and may trigger the 25% penalty
EA Exam Tip: The 25% SIMPLE penalty is one of the most frequently tested early withdrawal topics. Remember: first 2 years = 25%, after 2 years = 10%.
Exceptions to the 10% Penalty
The following exceptions waive the 10% (or 25%) additional tax. Some apply to ALL retirement accounts, while others are specific to IRAs or employer plans.
Exceptions That Apply to BOTH IRAs and Employer Plans
| Exception | Details | IRC Section |
|---|---|---|
| Death | Distribution to beneficiary after account owner's death | 72(t)(2)(A)(ii) |
| Disability | Total and permanent disability (unable to engage in substantial gainful activity) | 72(t)(2)(A)(iii) |
| SEPP/72(t) | Substantially Equal Periodic Payments over life expectancy; must continue for 5 years OR until age 59-1/2 (whichever is longer) | 72(t)(2)(A)(iv) |
| Medical expenses > 7.5% AGI | Unreimbursed medical expenses exceeding 7.5% of AGI; distribution must be in same year expenses paid | 72(t)(2)(B) |
| IRS levy | Funds withdrawn to pay IRS levy on the retirement account | 72(t)(2)(A)(vii) |
| Qualified reservist | Reservist called to active duty for 180+ days or indefinitely; distribution during active duty period | 72(t)(2)(G) |
| Birth or adoption | Up to $5,000 per parent per event within 1 year of birth/adoption; can be repaid within 3 years | 72(t)(2)(H) |
| Terminal illness | Physician certifies illness expected to result in death within 84 months (7 years); no dollar cap; can repay within 3 years | SECURE 2.0 (effective 2023) |
| Domestic abuse victim | Lesser of $10,000 (indexed) or 50% of vested balance within 1 year of abuse; self-certification allowed; can repay within 3 years | SECURE 2.0 (effective 2024) |
| Emergency personal expense | Up to $1,000/year; only one per year unless repaid (or 3 years pass) | SECURE 2.0 (effective 2024) |
| Federally declared disaster | Up to $22,000 within 180 days of disaster declaration; can repay within 3 years | SECURE 2.0 (effective 2023) |
| Long-term care insurance premiums (NEW — effective 2026) | Up to $2,500/yr to pay qualifying LTC insurance premiums | SECURE 2.0 (effective 2026 — NOT for 2025 tax year) |
Exceptions for IRAs ONLY
These exceptions apply to Traditional IRAs, Roth IRAs, SEP-IRAs, and SIMPLE IRAs (after the 2-year period), but NOT to 401(k), 403(b), or other employer plans.
| Exception | Details | Limits |
|---|---|---|
| First-time home purchase | Buy, build, or rebuild a first home for self, spouse, child, grandchild, or ancestor | $10,000 lifetime limit |
| Higher education expenses | Tuition, fees, books, supplies, and room/board (if enrolled at least half-time) for taxpayer, spouse, children, or grandchildren | No dollar limit |
| Health insurance while unemployed | Premiums for self, spouse, and dependents after receiving 12 consecutive weeks of unemployment compensation | Must be in year of or after unemployment |
First-Time Home Purchase Definition: A "first-time homebuyer" is someone who has not owned a principal residence in the 2 years before the acquisition date. Both spouses must meet this requirement.
Exceptions for Employer Plans ONLY (401(k), 403(b), etc.)
These exceptions apply to qualified employer plans but NOT to IRAs.
| Exception | Details | Who Qualifies |
|---|---|---|
| Separation from service at age 55+ (Rule of 55) | Leave employer in or after the year you turn 55 | 401(k)/403(b) participants; must separate from employer sponsoring that specific plan |
| Public safety age 50 or 25 years of service | Separation from service at age 50+ OR with 25 years of service | State/local/federal law enforcement, firefighters (including private-sector firefighters under SECURE 2.0), corrections officers, air traffic controllers |
| QDRO (Qualified Domestic Relations Order) | Distributions made pursuant to divorce decree to alternate payee (spouse, former spouse, child, other dependent) | 401(k)/403(b)/pension plans only |
| 457(b) governmental plans | Distributions from 457(b) governmental plans are exempt from the 10% penalty regardless of age | State/local government employees |
| ESOP dividends | Dividends paid on employer securities held in ESOP | ESOP participants |
Rule of 55 Important Details:
- Applies only to the plan at the employer from which you separated
- Does NOT apply to IRAs (even if you rolled over from that employer's 401(k))
- Must separate in or after the year you turn 55 (not before)
- Some plans may not allow this exception—check plan documents
SECURE Act 2.0 Exceptions in Force for 2025
1. Emergency Personal Expense Distributions
| Feature | Rule |
|---|---|
| Amount | Up to $1,000 per year |
| Definition | Unforeseeable or immediate financial needs for personal/family emergencies |
| Frequency | One emergency distribution per year (unless repaid or 3 years pass) |
| Repayment | May repay within 3 years to avoid income tax |
| Self-certification | Administrator may rely on employee's written certification |
2. Domestic Abuse Victim Distributions
| Feature | Rule |
|---|---|
| Amount | Lesser of $10,000 (indexed for inflation starting 2025) OR 50% of vested balance |
| Timing | Within 1 year of being a victim of domestic abuse |
| Definition | Physical, psychological, sexual, emotional, or economic abuse |
| Self-certification | Administrator may rely on participant's self-certification |
| Repayment | May repay within 3 years; receive tax refund for repaid amounts |
3. Terminal Illness Distributions
| Feature | Rule |
|---|---|
| Certification | Physician must certify terminal illness expected to result in death within 84 months (7 years) |
| Amount | No dollar limit |
| Repayment | May repay within 3 years |
| Effective date | Distributions on or after December 29, 2022 |
4. Federally Declared Disaster Distributions
| Feature | Rule |
|---|---|
| Amount | Up to $22,000 per disaster |
| Timing | Distribution within 180 days of disaster declaration |
| Location | Taxpayer's principal residence must be in declared disaster area |
| Repayment | May repay within 3 years |
| Tax treatment | Can spread income over 3 years if not repaid |
Comprehensive Exception Comparison Table
| Exception | IRA | 401(k)/403(b) | Form 5329 Code |
|---|---|---|---|
| Age 59-1/2 or older | Yes | Yes | 01 |
| Death | Yes | Yes | 04 |
| Disability | Yes | Yes | 03 |
| SEPP/72(t) | Yes | Yes | 02 |
| Medical expenses > 7.5% AGI | Yes | Yes | 05 |
| Health insurance (unemployed) | IRA only | No | 07 |
| Higher education expenses | IRA only | No | 08 |
| First-time home ($10K lifetime) | IRA only | No | 09 |
| IRS levy | Yes | Yes | 10 |
| Qualified reservist | Yes | Yes | 11 |
| Birth or adoption ($5K) | Yes | Yes | 12 |
| Separation age 55+ (Rule of 55) | No | Plans only | 01 |
| Public safety age 50+ / 25 yrs | No | Plans only | 01 |
| QDRO (divorce) | No | Plans only | 06 |
| 457(b) governmental | N/A | 457(b) only | — |
| Terminal illness | Yes | Yes | 13 / 20 |
| Domestic abuse victim | Yes | Yes | 22 |
| Emergency personal expense | Yes | Yes | 21 |
| Federally declared disaster | Yes | Yes | 24 |
(Form 5329 codes vary by IRS form-year; use the codes printed on the current-year form instructions.)
Form 5329: Reporting Early Withdrawals
Form 5329 (Additional Taxes on Qualified Plans) is used to:
- Report early distributions subject to the 10% penalty
- Claim exceptions to the penalty
- Report other retirement plan penalties (excess contributions, missed RMDs)
When to File Form 5329
| Situation | Action |
|---|---|
| 1099-R shows exception code (e.g., Code 2, 3, 4) | No Form 5329 needed |
| 1099-R shows Code 1 (early distribution, no known exception) | File Form 5329 to claim exception |
| You qualify for exception not reflected on 1099-R | File Form 5329 with applicable code |
EA Exam Tip: If the 1099-R shows Code 1 in Box 7 (early distribution, no known exception), but the taxpayer qualifies for an exception, they must file Form 5329 and enter the applicable exception code to avoid the penalty.
Substantially Equal Periodic Payments (SEPP/72(t))
The SEPP exception allows penalty-free early withdrawals if distributions are taken as a series of substantially equal periodic payments.
Requirements
- At least annually: Payments must be made at least once per year
- Based on life expectancy: Using IRS-approved calculation methods
- Duration: Must continue for the longer of 5 years OR until age 59-1/2
Three IRS-Approved Calculation Methods
| Method | Description | Payment Amount |
|---|---|---|
| Required Minimum Distribution | Account balance / life expectancy factor (recalculated each year) | Variable (changes each year) |
| Amortization | Fixed payment based on account balance, life expectancy, and interest rate | Fixed |
| Annuitization | Fixed payment based on annuity factor from IRS mortality tables | Fixed |
One-Time Method Change
Taxpayers using the amortization or annuitization method may make a one-time irrevocable switch to the RMD method without penalty.
Penalty for Modification
If the SEPP is modified (other than the one-time switch or due to death/disability):
- Recapture of 10% penalty on ALL prior SEPP distributions
- Interest on the recaptured amount
- Applies to entire SEPP period, not just the year of modification
EA Exam Tips
SIMPLE IRA 25% Penalty: First 2 years = 25% penalty; after 2 years = standard 10%.
IRA-Only Exceptions: First-time home ($10K), higher education, health insurance while unemployed.
Plan-Only Exceptions: Rule of 55 (separation from service), QDRO, public safety age 50, 457(b) governmental.
Birth/Adoption: $5,000 per parent per event, within 1 year, can repay within 3 years.
SECURE 2.0 (active in 2025): Emergency $1,000/year; domestic abuse lesser of $10,000 or 50%; terminal illness (no cap); federally declared disaster $22,000.
Form 5329: Required when 1099-R shows Code 1 but taxpayer qualifies for an exception.
SEPP Duration: 5 years OR until age 59-1/2, whichever is LONGER.
Terminal Illness: Physician certifies expected death within 84 months (7 years).
Tom, age 45, started participating in his employer's SIMPLE IRA 18 months ago. In 2025 he wants to withdraw $15,000 to pay off credit card debt. What additional tax will he owe if no exceptions apply?
Sarah, age 52, is laid off from her job in 2025 and takes a distribution of $30,000 from her former employer's 401(k) plan. Which statement is correct regarding the 10% early withdrawal penalty?
Under SECURE Act 2.0 (in full effect for the 2025 tax year), which of the following is a NEW exception to the 10% early withdrawal penalty?