When the economy is down, sometimes once successful business owners have no better choice but to dip into that tax deferred retirement nest egg to get by. We are seeing an unprecedented number of tax returns with early retirement distributions from retirement accounts from 2009. When you receive that Form 1099-R, there are ten things the IRS wants you to remember.
1. Payments you receive from your Individual Retirement Arrangement before you reach age 59 ½ are generally considered early or premature distributions.
2. Early distributions are usually subject to an additional 10 percent tax. This is in addition to ordinary taxes on the income which were probably deferred when you originally contributed the amounts.
3. Early distributions must also be reported to the IRS. So don’t forget to send that 1099-R to your accountant. The IRS matches the information that your broker or plan administrator reports to the IRS with what you report on your tax return.
4. Distributions you rollover to another IRA or qualified retirement plan are not subject to the additional 10 percent tax. You must complete the rollover within 60 days after the day you received the distribution. This is important to remember if you change jobs or lose your job and need to roll your 401(k) into an IRA account.
5. The amount you roll over is generally taxed when the new plan makes a distribution to you or your beneficiary. In other words, you can only defer taxes on your retirement for so long. If you roll the money over tax free to a new account, it will still be taxable eventually when you distribute the funds.
6. If you made nondeductible contributions to an IRA and later take early distributions from your IRA, the portion of the distribution attributable to those nondeductible contributions is not taxed. This is to prevent double taxation. In other words, if you are taxed on the money before you put it in, you won’t be taxed on it again when you take it out. You will just be taxed on the earnings, unless it is a Roth account.
7. If you received an early distribution from a Roth IRA, the distribution attributable to your prior contributions is not taxed. See above. Roth contributions are non-deductible in the year they are made.
8. If you received a distribution from any other qualified retirement plan, generally the entire distribution is taxable unless you made after-tax employee contributions to the plan. See 6. above.
9. There are several exceptions to the additional 10 percent early distribution tax, such as when the distributions are used for the purchase of a first home, for certain medical or educational expenses, or if you are disabled. If you had qualified medical expenses but didn’t quite reach that magical 7.5% of AGI amount, or had higher education costs but your income is too high to benefit from education credits/deductions, you may still want to provide that information to your accountant if you took any early distributions from your retirement account. It could save you the 10% tax on early distributions.
10. For more information about early distributions from retirement plans, the additional 10 percent tax and all the exceptions see IRS Publication 575, Pension and Annuity Income and Publication 590, Individual Retirement Arrangements (IRAs). Both publications are available at IRS.gov or by calling 800-TAX-FORM (800-829-3676). Oh yes, or you could just call your accountant!