Early withdrawal penalty

Explanation

Retirement accounts are meant for retirement, so the tax code adds a 10% additional tax to the taxable part of distributions taken before age 59½. It comes on top of ordinary income tax and any state tax (a few states add their own penalty). For SIMPLE IRAs, the penalty is 25% during the first two years of participation.

Common exceptions include:

• Rule of 55: leaving an employer in or after the year you turn 55 (applies to that employer’s plan only)
• 72(t) SEPP: a series of substantially equal periodic payments
• Death or total and permanent disability, and terminal illness
• Unreimbursed medical expenses above 7.5% of AGI
• IRA-only: first-time home purchase (up to $10,000 lifetime), qualified higher education costs, health insurance premiums while unemployed
• SECURE 2.0 additions: birth or adoption (up to $5,000 per child), one emergency withdrawal of up to $1,000 a year, and withdrawals by domestic abuse victims (limits apply)
• IRS levies and certain military reservist distributions

Roth IRAs have special ordering rules: your direct contributions come out first and can be withdrawn at any time with no tax or penalty. Converted amounts are penalty-free once five tax years have passed since each conversion. Earnings withdrawn early are generally taxed and penalized.

In scenarios, the app applies the penalty when a plan draws from retirement accounts before 59½ without a qualifying exception, and models the exceptions you choose (Rule of 55, 72(t), Roth ladder).

Example

At age 45, you withdraw $20,000 from a traditional IRA. You are in the 22% federal bracket and no exception applies.

• Income tax: $20,000 × 22% = $4,400
• Early withdrawal penalty: $20,000 × 10% = $2,000
• Total federal cost: $6,400
• You keep $13,600 (before state tax), or 68% of the withdrawal

If instead you withdrew $20,000 of past Roth IRA contributions, the cost would be $0.