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If you receive a lump-sum pension distribution under conditions that the IRS considers "premature," you may be subject to a 10 percent excise tax penalty, in addition to the ordinary income tax on the amount. You can generally avoid this tax by rolling over the entire amount into an IRA and leaving it there; just remember that nearly identical penalties apply for premature distributions from IRAs.
As a general rule, a 10 percent penalty applies for taking a lump-sum distribution before age 59-1/2. A higher penalty (25 percent) applies for taking a distribution from a SIMPLE plan within the first two years of participation. Your 1099-R should show a distribution code of "S" in Box 7 if this 25 percent rate applies.
Exceptions for all plan types. The 10 percent penalty does not apply to qualified plans or IRAs if the distributions are:
Exceptions for IRAs. See also our discussion on premature distributions from IRAs and some special exceptions that can apply.
Exceptions for qualified retirement plans. The 10 percent penalty does not apply to qualified plans if the distributions are:
Exceptions for nonqualified annuities. The 10 percent penalty does not apply to payments from deferred annuity contracts not purchased by qualified employer plans (i.e., deferred annuities you purchased from a commercial provider) if the payments are:
Reporting the excise tax. If you owe only the extra 10 percent tax on premature distributions, and distribution code 1 is shown in Box 7 of your 1099-R, you can simply enter 10 percent of your taxable distribution on Line 58 of Form 1040. Write "no" on the dotted line next to Line 58 to show that you don't have to file Form 5329.
Otherwise, you must complete Form 5329, Additional Taxes Attributable to IRAs, Other Qualified Retirement Plans Annuities, Modified Endowment Contracts, and MSAs and attach it to your tax return. This form is also required if you meet an exception to the tax but your 1099-R form does not show distribution code 2, 3, or 4 in Box 7, or the code is incorrect.