Under tax current law, withdrawing funds from your IRA before you reach age 59½ will result in the imposition of a 10% penalty on the amount of the withdrawal, in addition to any tax liability you may be responsible for. This penalty applies unless the withdrawal meets one of the exceptions that are specified by law. Many individuals are at least somewhat familiar with a few of these exemptions, the most well-known of which are likely to be permissible early withdrawals for qualified educational expenses and the exception for certain withdrawals for first-time home buyers to purchase a primary residence. But there are also some other exceptions that are not quite as well known.
For example, the Pension Protection Act of 2006 created a new exception (which was later extended by the Heroes Earnings Assistance and Relief Tax Act of 2008) to waive the 10% early withdrawal penalty on any “qualified reservist distribution.”
Definition of Qualified Reservist Distribution
A “qualified reservist distribution” is defined to include a distribution that’s taken from an IRA by an individual who was ordered or called to active military for a period of at least 180 days (or for an unspecified or indefinite term), where such distribution was taken during the period that begins on the date the individual received that call to active duty, and which ends upon the end of the active duty period.
Timing is Important. Note that the terms of the exception are very specific with regards to when the penalty free withdrawals may be made. They reservist may not take a qualified distribution in anticipation of active service, or any later than 180 days after being called to service – doing so will subject that distribution to the 10% penalty.
Repayment Option. The account holder who takes a qualified reservist distribution may re-contribute the amounts they took from their account. These re-contributions must occur during the two year period that begins on the day immediately after the end of that individual’s active duty period. Significantly, these re-contributions do not affect the contributions that the individual would otherwise be able to make during that tax year.
Long Term Impacts of Early Distributions. It’s important to remember that even though a penalty-free early distribution may be available to you, that doesn’t necessarily mean it’s something you should use. By withdrawing funds from your IRA early, you’re missing out on the most valuable element of the IRA structure – tax advantaged growth. Even if you are able to repay a qualified reservist distribution back into your account within the two-year grace period, you’re still missing out on growth opportunities before the repayment.
It’s therefore advisable that the qualified reservist distribution only be used when necessary, and where there are no suitable alternatives. However, in that context the availability of these penalty free withdrawals can be of great value to military families who are in need of some financial flexibility.
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