Life & Health Insurance Exam (National Portion)Taxes, Retirement, and Other Insurance ConceptsMedium
A 55-year-old client is considering taking a distribution from their qualified retirement plan. They are still employed and have not reached age 59½. Which of the following is most likely to apply to this distribution?
- AThe distribution will be subject to capital gains tax.
- BThe distribution will be subject to ordinary income tax and a 10% penalty.
- CThe distribution will be subject to a 20% early withdrawal penalty.
- DThe distribution will be tax-free.
Show answer & explanationAnswer & explanation
Correct answer: B. The distribution will be subject to ordinary income tax and a 10% penalty.
Distributions from qualified retirement plans before age 59½ are generally subject to ordinary income tax and a 10% early withdrawal penalty, unless an exception applies. Since the client is still employed and not 59½, this is the most likely outcome.
Why the other options are wrong
- A. Distributions from qualified retirement plans are taxed as ordinary income, not capital gains.
- C. The early withdrawal penalty is generally 10%, not 20%, for qualified plans.
- D. Distributions from qualified plans are taxable as ordinary income, not tax-free, unless they are qualified distributions from a Roth account.
Early Withdrawal from Qualified Plan
Taking money from a qualified retirement plan (e.g., 401(k), 403(b), IRA) before age 59½, typically results in ordinary income tax plus a 10% penalty.
- Applies to pre-tax contributions and earnings.
- Penalty is 10% of the taxable amount.
- Several exceptions exist (e.g., disability, medical expenses, first-time home purchase).
Memory trick: Early withdrawal means extra taxes and a penalty, like a financial 'time-out'.