What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


How to Calculate Retirement Penalty if Cashed Out

Original post by Mark Kennan of Demand Media

The IRS charges extra penalties on early withdrawals.

The federal government recognizes a number of qualified retirement plans, such as IRAs and 401k and 403b plans, and grants these plans special tax treatment to encourage retirement savings. These savings benefit people who leave the money in the account until they can take qualified distributions, typically when they turn age 59 1/2, but the Internal Revenue Service imposes penalties on early distributions. The early withdrawal penalty only applies to the taxable portion of the distribution, and in certain scenarios, you may qualify for an exemption that further lowers your early withdrawal penalty for cashing out your retirement plan.

Contents

Step 1

Calculate the taxable portion of the retirement withdrawal by subtracting the amount of nondeductible contributions made to the account from the account total. For example, if your account total equals $58,000 and you made $37,000 of nondeductible contributions, subtract $37,000 from $58,000 to find you have $21,000 in taxable distributions. If you have a tax-deferred account, such as a traditional IRA or 401k or 403b plan, unless you specifically made nondeductible contributions, the entire amount of the early withdrawal is taxable.

Step 2

Subtract from the taxable portion any amounts of exemptions from the early withdrawal penalty. For example, IRAs permit penalty-free early withdrawals for postsecondary education expenses, so if you had $9,000 of qualifying higher education expenses, subtract $9,000 from $21,000 to get $13,000 subject to the penalty.

Step 3

Multiply the amount subject to the early withdrawal penalty by 0.1, or 10 percent, to calculate the amount of the early withdrawal penalty for cashing out your retirement account. In this example, multiply $13,000 by 0.1 to find that your early withdrawal penalty equals $1,300.


                   

Tips & Warnings

  • Contributions to (but not earnings on) a Roth IRA can be withdrawn at any time without tax or penalty.

References

About the Author

Mark Kennan is a freelance writer specializing in finance-related articles. He has worked as a sports editor for "Ring-Tum Phi" and published articles on a number of online outlets. Kennan holds a Bachelor of Arts in history and politics from Washington and Lee University.

Photo Credits

  • Creatas/Creatas/Getty Images


Advertisement