Early Withdrawal Definition

early withdrawal

When an early withdrawal is made by a saver or an investor, some sorts of taxes or pre-specified fees are incurred. The aim of these fees is to discourage frequent or immature withdrawals before the early withdrawal period ends.

With such a penalty in place, a withdrawal is only made when there are pressing financial needs or a better investment plan to better use the fund.

Many long-term savings plans such as certificate of deposits have fixed terms which can range from 6 months to 5 years. Savers are fined if they touch the money saved in CDs before the end of the term, although the severity of this decreases as the maturity period draws nearer. For instance, a larger fee is imposed on you if you withdraw during the 2nd month than when you withdraw in the 21st month.

Most deferred annuities or life insurance policies also have an accumulation phase which is the lock-up period during which penalties will be charged if you withdraw early, this is known as the surrender charge.

What is an early withdrawal?

early withdrawal

An early withdrawal is the partial or total removal of funds from fixed-term investments like a certificate of deposits, annuity, or qualified retirement accounts before the end of the maturity date. Tax-deferred money always incurs penalties and charges if the fund is withdrawn from the retirement account before you are 59½ years.

Early withdrawal tips

  • Early withdrawals are the main attributes of fixed-term investments like certificates of deposits, annuity, life insurance, or qualified retirement accounts.
  • Early withdrawal is when funds that are saved in a fixed-term investment are withdrawn before the maturity date ends.
  • Penalties, fees, and taxes owed are the results of an early withdrawal from such products.
  • IRS states that early withdrawal occurs for qualified retirement accounts, such as 401k, when the withdrawal is made before the saver reaches the age of 59½ years.

Required minimum distributions and early withdrawal

If a saver withdraws before the maturity period, taxes are levied against such withdrawal. On the other hand, if withdrawals are not made at some point, the account holder can also be penalized. For instance, in a SEP, traditional, or SIMPLE IRA, holders of such an account must start withdrawing by the 1st of April following the year they attain the age of 72.

The retiree must withdraw a specified amount each year based on the calculation of the current required minimum distribution (RMD). This is determined by dividing the last year-end retirement account fair market value by life expectancy.

Tax-deferred investment accounts and early withdrawal

early withdrawal

The application of early withdrawal is also seen in tax-deferred investment accounts. The 401k and the traditional IRA are 2 major examples of this. In a traditional IRA, the direct pre-tax income of an individual towards tax-deferred investment with no dividend income or capital gains is taxed until withdrawn. Both employers and individuals have the sole right to sponsor or set up IRAs.

Early withdrawal penalties also affect Roth IRA investment growth, although it doesn’t affect the principal paid in.

Salary deferred contributions may be made by eligible employees on both post-tax and pre-tax basis in a 401k plan that is sponsored by an employer. Employers can also make non-elective or match contributions on eligible employee’s behalf and a profit-sharing feature may also be added. Just like an IRA, 401k earnings are tax-deferred.

For instance, in a traditional IRA, any amount taken from the account, before the account holder reaches the age of 59½ years of age, is subjected to a 10% early withdrawal penalty fee, and any deferred taxes that is due must also be paid with the penalty.

However, the withdrawal could be exempted from the penalty if it meets any of the following:

early withdrawal

  1. The fund is for rebuilding or purchasing a first home of the account holder or qualified family member, and this is limited to $10,000 per lifetime.
  2. The account holder is disabled prior to the occurrence of the distribution.
  3. The assets are received by a beneficiary after the death of the account holder.
  4. The fund is used for the expenses of higher education.
  5. The distribution occurs due to levies by the IRS.
  6. It is a non-deductible contribution return.
  7. The distribution is part of a substantially equal periodic payment (SERP) program.
  8. The assets are used for medical insurance (in case the account holder loses their employer’s insurance) or for medical expenses which weren’t reimbursed.
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