Withdrawing From a SEP-IRA or a Tax Deferred Annuity

Technically, you can ALWAYS withdraw from your Simplified Employee Pension (SEP-IRA) or your Tax Deferred Annuity. However, it is not advised to withdraw funds prior to reaching the age of 59 1/2.

Likely Consequences For Early Withdrawal - 10% Penalty If you are under the age of 59 1/2, there may be significant tax consequences from withdrawing. Specifically, you are likely subject to a 10% IRS penalty for early withdrawal of both a Simplified Employee Pension (SEP-IRA) & a Tax Deferred Annuity. This 10% penalty is in addition to the ordinary income tax rate you would normally pay.

General Example For instance, if, of the total $10,000 value of the two plans, $2,000 is taxable, you would be subject to ordinary income tax (i.e.~35%) of the $2,000 or $700 and an ADDITIONAL IRS Penalty of 10% of $2,000 or $200, bringing your total taxes to $900.

However, there are certain exceptions for early withdrawal of each retirement plan in which you would NOT be subject to the 10% IRS tax rule.

No Penalty Exceptions - Simplified Employee Pension (SEP-IRA) The exceptions to the 10% IRS penalty rule are if the withdrawal was:

1. Death/Disability - upon death or having developed a disability

2. Payment Plan - part of "substantially equal payments" over your lifetime

3. Medical Expenses - for payment of un-reimbursed medical expenses exceeding 7.5% of your adjusted gross income

4. Medical Insurance - for payment of your medical insurance or your spouse & dependents medical insurance. The withdrawal must occur during these scenarios:

a) if they lost their job,

b) have received unemployment for 12 weeks straight,

c) receives the unemployment on the following year or

d) receives distributions no later than 60 days after re-employment.

5. Higher Education Expenses - for qualified higher education expenses

6. Home Purchase - for the purchase, build or renovation of a first home for the first $10,000

No Penalty Exceptions - Tax Deferred Annuity The exceptions to the 10% IRS penalty rule are if the withdrawal was:

1. Death/Disability - upon death or having developed a disability

2. Older than 55 - when you were 55 or older and you retired or left your job

3. Payment Plan - part of "substantially equal payments" over your lifetime

4. Medical Expenses - for payment of un-reimbursed medical expenses exceeding 7.5% of your adjusted gross income

5. Divorce - required by a divorce decree or separation agreement ("qualified domestic relations court order")

Another Option - Rollover Tax Free Another option instead of withdrawing funds from either of these two accounts, is rolling them into another retirement plan tax-free such as a traditional IRA or other qualified retirement plan. Other plans, such as a Roth IRA, may provide additional tax benefits to you.

Final Note - 2010 Traditional IRA Conversion into a Roth IRA In 2010, Traditional IRA conversions into a Roth IRA are allowed for everyone, even if you don't currently qualify for the conversion. Remember, Roth IRA's are funded with After-Tax Dollars BUT Grow Tax Free and are NOT subject to tax following withdrawal after the age of 59 1/2. Please note that the additional income taxes due to the conversion, can be spread over two years (i.e. 2011 and 2012 returns).

Ryan S. Himmel is the founder of the website BIDaWIZ - the online marketplace for trusted answers from licensed business professionals (i.e. CPAs, CFAs, CFPs & More).

Visit us at BIDaWIZ to ask retirement planning questions or any financial concern.

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