Can I Deduct an Early Pension Withdrawal Fee?

Pensions are retirement accounts normally funded by your employer. Your employer makes contributions to the plan, invests those contributions, then distributes them to you when you retire. Pension plan assets created by your employer are tax deductible to your employer, but not to you.

Significance

Early distributions from a pension are allowed for any pension but may be subject to a fee as well as penalty tax. The fee charged against your withdrawals would be assessed by the pension plan, while the penalty tax is assessed by the IRS. The fees and penalties are there to encourage you to take a long-term view of your pension and to discourage early distributions from the plan.

Effect

A fee would not be deductible on your taxes because the fee is not a capital loss. It's also not a loss you experienced from a contribution to the plan, since your employer made the contributions to your pension plan. Any losses would be deductible to your employer, if the plan allowed for such loss deductions. A penalty tax is a tax that is also not deductible on your tax return. While the fee varies, depending on your employer's pension plan, the penalty tax is 10 percent of the amount you withdraw if you're under age 59 1/2.

Solution

You can eliminate pension fees and a penalty tax by seeing regular income distributions under IRS section 72t. The withdrawal exemption under this section will eliminate the penalty tax if payments are made in substantial and equal amounts for at least five years or until you are 59 1/2, whichever is longer. The fee for early distribution from your pension may or may not be waived if you are making withdrawals under this IRS exemption.

Consideration

You should consider drawing money from your own personal retirement plan before making early withdrawals from a pension. An IRA allows you to take IRS section 72t withdrawals without paying a fee to the IRA custodian. Likewise, 401k plans normally allow for such distributions, provided you are no longer working for the employer or he has allowed in-service withdrawals after age 59 1/2.

References

• IRS: Publication 575
• "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, et al.; 2007