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Question: My client owns a deferred annuity. She will turn 59 ½ later in this calendar year. If she takes a taxable withdrawal now, is she subject to the penalty tax?
Answer: Yes. Early taxable distributions are subject to the 10% penalty tax unless a specific exception applies. The age 59 ½ exception is strictly construed.
Here’s the critical language from Revenue Code Section 72(q):
(q) 10-percent penalty for premature distributions from annuity
(1) Imposition of penalty
If any taxpayer receives any amount under an annuity contract,
the taxpayer's tax under this chapter for the taxable year in
which such amount is received shall be increased by an amount
equal to 10 percent of the portion of such amount which is
includible in gross income.
(2) Subsection not to apply to certain distributions
Paragraph 1 shall not apply to any distribution -
(A) made on or after the date on which the taxpayer attains
age 59 1/2,
The interpretation is the same for taxable distributions from an IRA or other qualified plan. Here’s the IRS’s explanation of the penalty tax from Publication 590, which applies to IRA distributions:
Generally, if you are under age 59½, you must pay a 10% additional tax on the distribution of any assets (money or other property) from your traditional IRA. Distributions before you are age 59½ are called early distributions.
The 10% additional tax applies to the part of the distribution that you have to include in gross income. It is in addition to any regular income tax on that amount.
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