Husband's relocation due to military service does not avoid the 10% penalty on premature retirement plan distributions
I can’t tell you how many clients have come to me ill-informed because they thought just because their employer’s retirement plan allowed them to make a “hardship withdrawal” that they weren’t going to be subject to the 10% penalty for withdrawing these funds before age 59½. In very rare exceptions the penalty can be waived, however, most clients end up stuck with the penalty.
I love a good US Tax Court case. You can read the 3 page summary opinion here. Although they can’t be treated as precedent, they provide me with valuable insight to what tax problems might be appealed when the IRS and I disagree on an issue.
This case involved a middle-aged couple. In 2004, the husband was on active duty in the Army and received orders to move from Texas to Hawaii. The wife withdrew the balance from her retirement plan to pay for their unreimbursed moving and living costs related to the move until the Army provided permanent housing. The couple, however, did not pay the 10% penalty on the withdrawal (she was age 51 when the money was withdrawn) and the IRS sought to collect the penalty.
The case wound up in US Tax Court. Although the couple conceded they did not qualify for one of the exceptions to the penalty (death, disability, medical expenses, withdrawn over age 59 ½ or separated from service after age 55), they contended that the should not be subject to the penalty on account of the financial hardship imposed by the husband’s military service and related relocation.
Quoted directly from the Tax Court’s Summary Opinion: “Although we are sympathetic to the petitioner’s plight, none of the exceptions set forth in section 72(t) (2) apply in this case. Accordingly, respondent’s [the IRS] determination is sustained.”
Personally, I feel that relocation and living expenses incurred due to military service deserves a full waiver of the 10% penalty. However, this case proves that even in extreme extenuating circumstances, the IRS will almost always prevail in cases of premature distribution penalties.
Bottom line… avoid raiding IRAs, 401(k)s, SEPs, SIMPLES or other retirement plans before age 59½ or be prepared to pay the tax. The IRS (or the courts) does not have the authority to waive the penalty unless the withdrawal meets one of the statutory exceptions to the penalty.
As always, if you have any questions regarding premature retirement plan distributions please feel free to call or email me. Exceptions do exist, but the vary depending on the type of retirement plan you have.
