Definition
An extra 10% federal tax on money taken from a traditional IRA, 401(k), or similar retirement account before age 59½, charged on top of the regular income tax owed on the withdrawal. Exceptions exist for disability, certain medical costs, a first-home purchase from an IRA, and other listed situations. The phrase also describes the interest a bank keeps when you cash out a CD before it matures.
Why it matters
The penalty is what makes a retirement account a poor emergency fund: a withdrawal can lose a third or more to tax and penalty combined, plus all the growth that money would have earned. Knowing the exceptions matters too, since some people pay a penalty they could have avoided.
Example
A 40-year-old cashes out a $20,000 traditional 401(k) after leaving a job. At a combined federal and state marginal rate of 27%, they owe about $5,400 of income tax plus a $2,000 penalty, keeping roughly $12,600. Rolling it into an IRA instead would have kept the full $20,000 invested.
Put it into practice
Related terms
This definition is educational, not financial, legal, or tax advice. U.S. rules and limits change; verify time-sensitive details with official sources. See our disclaimer.