What is a 'Withdrawal Penalty'

A withdrawal penalty refers to any penalty incurred by an individual for early withdrawal from an account that is either locked in for a stated period, as in a time deposit at a financial institution, or where such withdrawals are subject to penalties by law, such as from an IRA.

BREAKING DOWN 'Withdrawal Penalty'

A withdrawal penalty can vary depending on the type of funds or financial instrument involved, along with other factors. The penalty can be either in the form of forfeiture of interest or an actual dollar amount. When you open an account or become a participant in a retirement plan, you will generally receive in-depth documentation that spells out all of the terms of the arrangement or contract. This typically includes details about what constitutes an early withdrawal, and what penalties, if any, you would incur should you decide to make an early withdrawal from that account.

For example, an early withdrawal from a certificate of deposit at most financial institutions would result in the customer forfeiting interest for a period ranging from one month to several months. Generally speaking, the longer the term of the initial certificate of deposit, the longer the interest forfeiture period.

Withdrawal Penalties for IRA Accounts

In the case of IRAs, withdrawals before the age of 59.5 are subject to a penalty of 10 percent. The Internal Revenue Service does allow for some exceptions to the tax penalties for early withdrawal of IRA funds, under certain circumstances. For example, the penalties may be waived if the funds were withdrawn because the person lost their job and needs funds to make the premium payments on their medical insurance policy. In addition, an early withdrawal may be exempt from tax penalties if the funds are being used for tuition expenses for the account holder, their spouse or their spouse or other dependent. Certain restrictions and conditions apply, so it’s important to review the rules set by the IRS prior to taking any actions involving withdrawing funds early from an IRA account.

The withdrawal penalty for taking funds from an IRA or other account can be steep, so it is wise to consider other strategies for obtaining necessary funds that would not involve the possibility of a significant penalty.

An alternative option might be to take a retirement plan loan. The proceeds of that type of loan are not taxable if the loan abides by certain rules, and repayment follows the required schedule and terms.
 

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