how a withdrawal penalty works
a withdrawal penalty can vary depending on the type of funds or financial instrument involved along with other factors the penalty can be either in the form of forfeiture of interest or an actual dollar amount when you open an account or become a participant in a retirement plan you will generally receive in depth documentation that spells out all of the terms of the arrangement or contract this typically includes details about what constitutes an early withdrawal and what penalties if any you would incur should you decide to make an early withdrawal from that account for example an early withdrawal from a certificate of deposit cd at most financial institutions would result in the customer forfeiting interest for a period ranging from one month to several months generally speaking the longer the term of the initial certificate of deposit the longer the interest forfeiture period an alternative option to taking an early withdrawal is taking a qualified retirement plan loan withdrawal penalties for ira accountsin the case of iras withdrawals before the age of 59 are subject to a penalty of 10 of course you ll also have to pay income taxes on the amount withdrawn from a traditional ira or 401 k since it ll be considered taxable income the amount you d pay would be dependent on your total annual income and the subsequent income tax bracket 1the internal revenue service irs does allow for some exceptions to the tax penalties for early withdrawal of ira funds under certain circumstances for example the penalties may be waived if the funds were withdrawn because the person lost their job and needs funds to make the premium payments on their medical insurance policy also an early withdrawal might be exempt from tax penalties if the funds are being used for tuition expenses for the account holder their spouse or their children or grandchildren certain restrictions and conditions apply so it s important to review the rules set by the irs prior to taking any actions involving withdrawing funds early from an ira account 2it s important to note that a qualified plan such as a 401 k can have different rules and penalties for early distributions versus a traditional ira for example the early withdrawal exception for iras doesn t apply to qualified plans for those who are unemployed and wish to use ira funds for health insurance premiums 3the withdrawal penalty for taking funds from an ira or other accounts can be steep so it is wise to consider other strategies for obtaining necessary funds that would not involve the possibility of a significant penalty an alternative option might be to take a qualified retirement plan loan the proceeds of that type of loan are not taxable if the loan abides by certain rules and repayment follows the required schedule and terms 4example of a withdrawal penalty annuity surrender chargesmany deferred annuities have a withdrawal penalty in the early years of the contract known as a surrender charge in such an annuity an individual places either a lump sum of money or regular installment payments into an account often with an insurance company some years later that accumulated money is converted into a regular cash flow stream in many cases until the annuity holder dies if the annuitant chooses to take out some of the contributed funds before the annuitization phase there will be a withdrawal penalty the size of the surrender fee will vary among insurers and may be something like 10 if money is touched in the first year or two generally this penalty decreases over time so it may only be 5 in the fifth year and 1 in the tenth year as an example 5