Early Withdrawal Penalty

What Is An Early Withdrawal Penalty?

An early withdrawal penalty refers to legal charges incurred by depositors for withdrawals from accounts that were fixed for specified periods. They could be costly and are put in place to dissuade individuals from removing funds early from such accounts.

Deeper Definition

In certain accounts, like an individual retirement account (IRA) or a certificate of deposit that is locked in or time-specific, penalties are attached when withdrawals are made ahead of schedule. This is because the financial institutions where these funds are kept usually use the said funds -deposited to investment accounts, deposit accounts, and so on- for investment purposes of their own to record profits. Usually, in such cases of default, by failing to hold up to their end of the agreement, the depositors put the banks in a difficult situation as they will be unable to fulfill their obligations to other depositors.

The early withdrawal penalty serves to reduce the incidence of these situations. Thus, they are charged against accounts designated to have fixed maturity dates or expiry periods before withdrawals can be made. There are provisions for waivers of penalties in certain exceptional cases where early withdrawals have to be made. For instance, when a high medical expense has been incurred, or a qualifying home purchase has to be made, consideration may be given for a waiver. However, it is essential to note that requirements for consideration vary from one financial institution to another.

Early Withdrawal Penalty Example

Suppose Sharon, a holidaymaker, has $100,000 in her retirement account and intends to take a vacation to tour the African continent. In that case, she might decide to withdraw $10,000 from the account for that purpose. However, if she is in her early forties, nowhere near the retirement age of 59.5 years, the federal government might impose a 20% early withdrawal penalty on her, in which case she is due to make a payment of $2,000 as an early withdrawal penalty.

Additionally, she will be required to pay taxes on the withdrawn amount of $10,000 when her taxes are filed for the year in review.