What Is a Premature Distribution?

A premature distribution or early withdrawal is any distribution taken from an individual retirement account (IRA), 401(k) investment account, a tax-deferred annuity, or another qualified retirement-savings plan that is paid to a beneficiary who is younger than 59½ years old.

Premature distributions are subject to a 10% early withdrawal penalty by the Internal Revenue Service (IRS) as a means of discouraging savers from spending their retirement assets prematurely.

How Premature Distribution Works

There are several instances in which the premature distribution penalty rules are waived, such as for first-time homebuyers, education expenses, medical expenses, and Rule 72(t), which states that a taxpayer can take IRA withdrawals before they are 59½ as long as they take at least five substantially equal periodic payments (SEPPs).

Early withdrawal applies to tax-deferred investment accounts. Two significant examples of this are the traditional IRA and 401(k). In a standard individual retirement account (IRA), individuals direct pretax income toward investments that can grow tax-deferred; no capital gains or dividend income is taxed until it is withdrawn. While employers can sponsor IRAs, individuals can also set these up individually.

In an employer-sponsored 401(k), eligible employees may make salary-deferral contributions on a post-tax and/or pretax basis. Employers have the chance to make matching or non-elective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature. As with an IRA, earnings in a 401(k) accrue tax-deferred.

Allowable Premature Distributions

In 1997, Congress passed the Taxpayer Relief Act, which among other things, enabled taxpayers to withdraw up to $10,000 from tax-sheltered retirement accounts if that money is used to purchase a home for the first time.

Students can also withdraw funds early from their qualified retirement accounts if they use the proceeds for qualified higher education expenses. Qualified expenses include tuition, supplies, or books needed to attend an accredited institution of higher learning.

Taxpayers cannot use funds withdrawn early for living expenses, but they can use those funds for medical expenses approved by the IRS in publication 502.

Beginning in 2024, the SECURE Act 2.0 of 2022, permits account participants to access up to $1,000 annually from retirement savings for emergency personal or family expenses without paying the 10% early withdrawal penalty. Additionally, survivors of domestic abuse will be able to withdraw the lesser of $10,000 or 50% of their retirement account and victims of a federally declared natural disaster can withdraw up to $22,000 from their savings without penalty.

Alternative Strategies to Avoid Fees for Premature Distributions

Rule 72(t) is another popular strategy for avoiding IRS-levied, early withdrawal fees. Rule 72(t) refers to the section of the tax code that exempts taxpayers from such fees if they receive those payments in Substantially Equal Periodic Payments. This means you must withdraw your funds in at least five installments over five years, making this strategy less than ideal for those who need all their savings right away.

Congress has written in these exceptions in the tax code to support taxpayer behavior, which it sees as in the public interest. While U.S. policymakers see promoting retirement savings as one of their top priorities, they have made exceptions in the cases of new homeowners or those overburdened with expenses related to schooling and medical care.

The Bottom Line

Premature distributions are early withdrawals from qualified retirement accounts such as IRAs or 401(k) plans. The IRS imposes a 10% penalty for withdrawals made from these accounts before age 59½, however, it allows for exceptions like hardship, a first-time home purchase, or qualified medical expenses.