5 Tips to Avoid the 10% Penalty on Early Distributions From IRAs and Employer Retirement Plans

Millions of Americans take billions of dollars in early distributions each year. Early distributions—those taken before age 59 ½—are subject to a 10% additional tax or early distribution penalty. There are exceptions to this early distribution penalty, but traps await those who do not have a clear understanding of how the exceptions work. If you are among the millions who will take early distributions this year, the following are tips on how to avoid these traps.

Mark the Day You Reach Age 59½

A common mistake with the age 59½ determination is thinking that it applies in the year of attainment. On the contrary, attainment occurs on the date the account owner reaches age 59½.

Example: Tom was born on June 15, 1966, and reached age 59 on June 15, 2025, and 59½ on Dec. 15, 2025.

Scenario 1: Assume Tom takes a distribution from his IRA on Dec. 1, 2025. That distribution is “early” and, therefore, subject to the 10% early distribution penalty unless Tom qualifies for an exception.

Scenario 2: Assume Tom waits until Dec. 15, 2025, to take the distribution. It would be normal (not early), and the 10% early distribution penalty would not apply

Verify Eligibility by Account Type

An individual who wants to claim an exception to the 10% early distribution penalty should check with their tax advisor to see if their account qualifies. Some exceptions apply to IRAs, some apply to employer plans, and some apply to both. Taking distributions from the “wrong” account type or moving from a qualifying account to a nonqualifying account could cause an individual to find that they are subject to the penalty when they had thought they qualified for an exception.

Example: 50-year-old Kendu was awarded $500,000 of his wife’s traditional 401(k) under a qualified domestic relations order.

Scenario 1: Assume 50-year-old Kendu requests a distribution of $100,000 from the $500,000. The $100,000 was paid to him. The 10% early distribution penalty will not apply because distributions under a QDRO are automatically exempt from the 10% early distribution penalty.

Scenario 2: Assume Kendu rolls over the $500,000 to his traditional IRA and then takes the distribution of $100,000. Kendu will owe the IRS a 10% early distribution penalty of $10,000 because the QDRO exception does not apply to distributions from IRAs. Kendu’s tax advisor will need to check if Kendu qualifies for any exceptions that apply to IRAs.

Another example is the age 55 exception discussed later.

Beware of Dollar Limitations

Some of the exceptions are subject to a dollar limit. For example, for the first-time homebuyer exception, the maximum amount that qualifies is $10,000, a lifetime limit. This limit applies on a per-person basis, whether the individual is married or not, which means that a married couple would qualify for a total of $20,000—$10,000 for each spouse. Other exceptions with dollar limitations include the $5,000 per child for qualified birth or adoption expenses and the $22,000 per qualified disaster recovery distributions made to qualified individuals.

Verify the Eligibility of the Person for Whom You Intend Coverage

As the owner or participant of the retirement account, you are always a qualifying party for any exceptions as long as you meet the requirements. However, some of the exceptions are extended to qualifying family members. Examples include distributions for first-time homebuyers, medical insurance, higher education expenses, and insurance premiums.

Distributions due to disability and distributions for domestic abuse are examples of distributions that cover only you or your status.

Timing Is Critical for Some Exceptions

Some of the exceptions apply only if they are made within a specific time frame. For example, the age 55 exception applies if the following three requirements are met:

1. Plan type: The distribution is made from an employer plan (not any type of IRA).
2. Age requirement: You stop working for the employer that provides the plan in the year you reach age 55 or later.
3. Distribution timing: The distribution is made after you stop working for that employer.

You will not qualify for this exception if you stop working before the year you reach age 55 and wait until age 55 to take the distribution.

Example 1: Tyrone’s employment with Widgets and Things was terminated on Dec. 31, 2024. Tyrone reached age 54 on Dec. 2, 2024.

In 2025, when he was 55, Tyrone withdrew $10,000 from his Widgets and Things 401(k) account. Tyrone does not qualify for the age 55 exception because he stopped working for Widgets and Things before that year.

Example 2: Sheree’s employment with Widgets and Things terminated on Jan. 31, 2025. Sheree was 54 at the time.

Sheree will reach age 55 on Sept. 30, 2025.

Sheree took a distribution from her Widgets and Things 401(k) account in March 2025, when she was 54. However, even though Sheree’s distribution occurred when she was 54, it qualifies for the age 55 exception because it meets the three requirements above: plan type, age requirement, and distribution timing.

Never Guess About Qualifications for Exceptions

Retirement savings are intended to provide income during retirement, which for most individuals starts later than age 59½ and would therefore avoid the 10% early distribution penalty. Sometimes, though, taking early distributions is inevitable. In such cases, strategies can be implemented to avoid or reduce income tax.

The 10% additional tax can be avoided only if certain requirements are met, and the requirements vary for each type of exception. The five rules in this article are only some of the many that should be considered. If you are planning to take an early distribution, consult with your tax advisor to determine if you have the type of account for the exception you seek, whether you qualify for an exception that you didn’t think of, and whether you must take steps to retain or gain qualification for an exemption.