Form 5329

Description

Form 5329 is used to report any additional income tax or excise tax (such as the 10% penalty on early distributions) you may owe in connection with IRAs, other qualified retirement plans, education savings accounts, modified endowment contracts, or MSAs.

An early distribution from your IRA or retirement plan (before you reach age 59 1/2) that you do not rollover into another IRA or qualified retirement plan within 60 days after you receive the distribution is usually subject to a 10 percent penalty. Exceptions to the 10 percent penalty include IRA distributions that are (1) used to pay medical expenses in excess of 7.5 percent of your adjusted gross income, (2) used to pay qualified higher-education expenses for you, your spouse, or dependents, (3) used by first-time homebuyers to pay up to $10,000 of qualified costs of acquiring a principal residence, (4) paid due to death or permanent disability, (5) paid in equal payments made at least annually based over the life expectancy of you and your designated beneficiary, or (6) used by an individual to pay health insurance premiums if the individual has been unemployed for a period of 12 weeks or more.

For employer retirement plans such as 401(k) plans, the 10 percent early distribution penalty will not apply if one of the following exceptions are met: (1) you retire, quit, or are fired from your job during or after the year you reach age 55, (2) death or permanent disability, (3) used to pay medical expenses in excess of 7.5 percent of your adjusted gross income, (4) paid in equal payments (after you retire, quit, or are fired from your job) made at least annually based over the life expectancy of you and your designated beneficiary, or (5) paid pursuant to a Qualified Domestic Relations Court Order, generally in connection with divorce or legal separation.

Tax Tips for Form 5329

If you are younger than age 59 1/2, think twice before you take an early distribution from your 401(k) or IRA account. A 10% early distribution penalty is charged along with federal and state tax on the distribution. A large distribution will bump a taxpayer up to a higher tax bracket, so you also end up paying a higher rate of taxes on your regular income.

If available, take a 401(k) loan instead of a distribution. Taking an early distribution subject to the 10% penalty from your 401(k) or other retirement plan is almost always a bad idea since you pay a lot of taxes and penalties on that distribution. One alternative to taking an early distribution may be to take a loan from your 401(k) or retirement plan. Not all retirement plans offer this option, but if they do then you can borrow part of your retirement plan money and pay it back over time. You pay interest on the 401(k) loan, but the interest goes into your 401(k) account so you are basically paying interest to yourself. There are a couple of negative things about 401(k) loans. First, if you leave your job before you are finished paying back the loan, you will need to pay back the rest of the loan or the remaining loan will be treated as an early distribution subject to the 10% penalty. Second, even though you are paying interest to yourself on the loan, you have taken money out that is no longer in the stock market, so if the stock market is providing a better return on investment than the interest you are paying, you are losing out. But even with these negatives, a 401(k) loan is absolutely better than taking an early distribution.

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