Ouch

I was listening to a conversation of someone encouraging an early distribution out of a qualified account to take a vacation. It’s like getting stung by a bee or a prick of a needle, early distributions from a qualified account have a tax “ouch” effect.

Remember, as you are working and you are contributing to your 401(k) plan, the contributions are tax-deferred. For example, you made $100,000 and you contributed $10,000 to your retirement plan, thus your taxable income is now reduced to $90,000.

If you take an early distribution from your retirement account, first you will be taxed on the base amount coming out, and then you will have an additional 10% early withdrawal penalty tax. Going back to your $10,000 base amount you contributed, if you are in the 22% tax bracket, that’s $2,200 right off the top, plus 10% of the base amount so another $1,000. Thus, the amount that actually hits your hands is $6,800.

There are some exceptions to avoiding the 10% penalty, but a vacation is not one.

https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions