Some early withdrawal tax exceptions apply to all qualified plans, while some apply only to traditional IRAs. Those listed in this section apply to all qualified plans, unless otherwise noted.

A taxpayer can avoid both the income tax and the penalty on an early distribution if the distribution is rolled over into an eligible retirement plan within 60-days of receipt (Code Sec. 402(c)(1)). The IRS may waive the 60-day rollover period for equitable reasons, including cases of casualty, disaster, or other events beyond an individual's control such as bank error, if certain conditions are met. (Code Sec. 402(c)(3)) Taxpayers may provide written certification to a plan administrator or an IRA trustee that he or she missed the 60-day deadline because of not being able to complete a rollover due to one or more of 12 situations provided for in Rev Proc 2020-46, modifying and superseding Rev Proc 2016-47. See page 04.04.07 for details.

Some taxpayers use the 60-day rollover provision as a source for a short-term loan. However, there are built-in hazards for the 60-day rule:

The IRS has adopted the Tax Court position but provided transitional relief by not applying the court’s interpretation to IRA rollovers occurring before January 1, 2015. (Ann. 2014-15) See Chapter 4.04 for additional information.

Amounts withdrawn to pay unreimbursed medical expenses that would be deductible on Schedule A during the year and that exceed 7.5% of the taxpayer's AGI are exempt from penalty. This is true even if the taxpayer does not itemize.

Enter unreimbursed medical expense…………………………………....... ___________

Enter 7.5% of the taxpayer’s AGI for the year…................................................ <___________>

Penalty exempt amount……………………………………………………….. ___________

If a taxpayer becomes disabled before reaching age 59-1/2, any amounts withdrawn because of the disability are not subject to the 10% additional tax. A taxpayer is considered disabled if the taxpayer can furnish proof that he/she cannot perform any substantial gainful activity because of the physical or mental condition that causes the disability. A physician must determine that the taxpayer's condition:
- Can be expected to result in death, or
- Is expected to be of a long, continued and indefinite duration.

In determining whether an individual's impairment makes him unable to engage in any substantial gainful activity, the regulations provide that the primary consideration is to be given to the nature and severity of the impairment, but other factors, such as the individual's education, training, and work experience, must also be considered. Substantial gainful activity is the activity, or a comparable activity, in which the individual customarily engaged prior to becoming disabled or prior to retirement if the individual was retired at the time the disability arose. Whether or not the impairment in a particular case constitutes a disability is to be determined with reference to all the facts in the case.  (Reg. 1.72-17A(f))

The following are examples of impairments that would ordinarily be considered as preventing substantial gainful activity:

The existence of one or more of the impairments described above will not, in and of itself always permit a finding that an individual is disabled as defined in Sec 72(m)(7). Any impairment, whether of lesser or greater severity, must be evaluated in terms of whether it does in fact prevent the individual from engaging in his customary or any comparable substantial gainful activity.

In contrast, and more typical of the outcome of cases involving mental illness, in an earlier 2003 case (Keeley v. Commissioner, TC Summary Opinion 2003-53), the Tax Court held that the taxpayer’s depression was not a qualified disability for the 10% penalty exception. In the Court’s opinion the taxpayer’s condition was remediable, and it did not require him to be institutionalized or put under constant supervision, conditions noted in the regulations for a mental illness to be a disability.

If a taxpayer dies, the benefits distributed to a taxpayer’s beneficiary or estate are exempt from the early withdrawal penalty. Caution: If a decedent’s spouse chooses to treat the distribution as his/her own and later receives a distribution before reaching age 59-1/2, it may be subject to the penalty.

This exception essentially allows a taxpayer to retire early and take withdrawals before reaching age 59-1/2 without penalty. For qualified plans, this exception applies only for distributions that begin after the taxpayer separates from service. To qualify for this exception, the payments:

Code Section 72(t) does not include a specific method of computing the payments.  In Notice 89-25, 1989-1 CB 662, modified by Rev. Rul. 2002-62 (which itself is modified and superseded by Notice 2022-06), the IRS suggests three methods that might be used in computing the payments.  Several letter rulings have also been issued approving other methods.    

The following summarizes the methods outlined in Rev. Rul. 2002-62. Methods 1 through 3, explained below, are applicable for any series of payments starting on or after January 1, 2003, but could have been used for distributions starting in 2002. As the examples for Methods 1 through 3 shows, the amount of the annual payment varies significantly with the method chosen.

CAUTION: The following examples use the pre-2022 life expectancy and distribution tables. In T.D. 9930

(Nov. 5, 2020), which provides updated tables, the IRS stated that they anticipate issuing guidance that would update Rev. Rul. 2002-62. This update would apply the life expectancy, distribution period, and mortality tables set forth in the revised regulations for purposes of determining substantially equal periodic payments once these regulations become effective, which is Jan. 1, 2022. That IRS guidance is included in Notice 2022-06.

Example: Taxpayer is age 55, spouse is age 50; qualified retirement plan account balance is $303.00; taxpayer's first distribution is in 2021. Generally, the Uniform Lifetime Table would be used, unless (1) there is no designated beneficiary, in which case the Single Life Expectancy Table is used, or (2) the distribution is from a Joint and Last Survivor annuity for which the Joint and Last Survivor Table is used.

Example: Same facts as above, plus the chosen interest rate is 3.5% (for the purpose of these examples, assume that this is an eligible rate). The annual distribution would be as follows depending on the Life Expectancy Table used:

Rules and definitions for Methods 1 – 3:

The revenue rulings that contain the applicable federal mid-term rates are available on the IRS web site by searching for “applicable federal rate”.

IRS Q&A from IRS.gov:

Q7. Can I change from one method to another in calculating substantially equal periodic payments?

Yes. Rev. Rul. 2002-62 permits a one-time change from either the amortization method or the annuitization method to the required minimum distribution method. (Notice 2022-06, section 3.03(b), confirms this rule.)

Q8. What is the effect of an account being completely depleted?

If there are no assets remaining in the individual account plan or IRA, the taxpayer will not be subject to the Code §72(t) tax because of not receiving substantially equal periodic payments. In addition, the recapture tax will not apply.

Q9. Are the three methods the only acceptable ways of determining substantially equal periodic payments?

No. Another method may be used in a private letter ruling request, but, of course, it would be subject to individual analysis.

Q10. Can I take the substantially equal payments on a monthly basis?

Yes. Monthly payments under the required minimum distribution method would be the calculated annual amount divided by 12. Under the amortization and annuity methods, the choice of having the payment made monthly should be part of the original calculation.

The 10% penalty tax on early withdrawals (under Code Sec. 72(t)) does not apply to withdrawals from a qualified plan or IRA made on account of a levy under Code Sec. 6331 on the plan or IRA. (§ 72(t)(2)(A)(vii))

This exception applies to distributions only if the qualified plan or IRA is actually levied on. The 10% penalty tax still applies if the taxpayer withdraws amounts from a qualified plan or IRA to pay taxes in the absence of a levy, or even if the taxpayer makes a plan or IRA withdrawal in order to cause the IRS to release a levy on a separate property interest of the taxpayer.

In another ruling, IRS privately held that a federal court seeking to collect a fine in an individual's criminal case would not violate the anti-alienation rule by garnishing the individual's Code Sec. 401(k) plan account balance. However, that ruling did not address the 10% additional tax, or whether the payments would be subject to mandatory withholding. See PLR 200342007.

The 10% early withdrawal penalty tax does not apply (retroactively) to a “qualified reservist distribution.” A qualified distribution is:
(1) From an IRA or attributable to elective deferrals under a 401(k) plan, 403(b) annuity, or certain similar arrangements;
(2) Made to individuals who (because of their being members of a reserve component) are ordered or called to active duty after Sept. 11, 2001, for a period of more than 179 days or for an indefinite period; and
(3) Made during the period beginning on the date of the order or call to duty and ending at the close of the active-duty period.

For distributions made after Dec. 31, 2019, the SECURE Act provides that withdrawals from retirement plans for a "qualified birth or adoption distribution" are not subject to the 10% early withdrawal penalty. This is a distribution to an individual made during the one-year period beginning on the date on which a child of the individual is born or on which the legal adoption by the individual of an eligible adoptee is finalized. An eligible adoptee means any individual (other than a child of the taxpayer's spouse)  who has not attained age 18 or is physically or mentally incapable of self-support. The maximum aggregate amount of a qualified birth or adoption distribution by any individual with respect to any birth or adoption is $5,000, applied on an individual basis (so each spouse separately may receive up to $5,000 of qualified birth or adoption distributions). Taxpayers must include the name, age, and taxpayer identification number (TIN) of the child or eligible adoptee on their tax return. In addition, such qualified birth or adoption distributions may be recontributed to an individual's applicable eligible retirement plans, subject to certain requirements. (Code Sec 72(t)(2)(H), as amended by SECURE Act Sec. 113)

o Who is diagnosed with the virus SARS-CoV-2 or with coronavirus disease 2019 (Covid-19) by a test approved by the Centers for Disease Control and Prevention,
o Whose spouse or dependent is so diagnosed, or
o Who experiences adverse financial consequences as a result of the coronavirus. (CARES Act Sec. 2202(a))

See Chapter 04.05 for additional details on coronavirus-related retirement plan distributions.

SECURE 2.0 Act Section 326 provides an exception to the additional 10% tax in the case of a distribution to an individual who is terminally ill on or after the date on which such employee has been certified by a physician as having a terminal illness.

A domestic abuse survivor may need to access his or her money in their retirement account for various reasons, such as escaping an unsafe situation. SECURE 2.0 Act Section 314 allows retirement plans to permit participants that self-certify that they experienced domestic abuse to withdraw a small amount of money not subject to the 10% early withdrawal penalty and not to exceed the lesser of:

A distribution is an eligible distribution if it is made during the 1-year period beginning on any date on which the individual is a victim of domestic abuse by a spouse or domestic partner.

Domestic abuse means physical, psychological, sexual, emotional, or economic abuse, including efforts to control, isolate, humiliate, or intimidate the victim, or to undermine the victim’s ability to reason independently including by means of abuse of the victim’s child or another family member living in the household.

Distribution may be repaid at any time during the 3-year period beginning on the day after the date on which such distribution was received.

SECURE 2.0 Act Sec 115 adds new IRC Sec 72(t)(2)(I) that provides a penalty exception for certain distributions used for emergency expenses, which are unforeseeable, or immediate financial needs relating to personal or family emergency expenses.

Only one distribution is permissible per year of up to $1,000, and a taxpayer has the option to repay the distribution within 3 years. No further emergency distributions are permissible during the 3-year repayment period unless repayment occurs.

The term “emergency personal expense distribution” means any distribution from an applicable eligible retirement plan (as defined in IRC Sec 402(c)(8)(B) other than a defined benefit plan) to an individual for purposes of meeting unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses. The administrator of an applicable eligible retirement plan may rely on an employee's written certification that the employee satisfies the conditions of the preceding sentence in determining whether any distribution is an emergency personal expense distribution. (Sec 72(t)(2)(I)(iv))

Applies to distributions made after December 31, 2023.