Qualified retirement plans and individual retirement accounts (IRAs) are great vehicles to take advantage of tax-deferred growth potential and save for retirement. When an individual eventually decides to tap into his or her retirement fund, withdrawals from these plans are subject to regular income taxes. There's one catch, however, for people who are under 59 1/2 years old. They will pay an additional 10 percent tax for premature distributions, in addition to the regular income tax, unless they can fit within one of the exceptions to this penalty tax.

Of the exceptions to the 10 percent premature distribution tax, all but two provide no real planning opportunities. Most are designed to relieve the burden imposed by a death, disability, serious illness, education costs, first-time home purchase or divorce. The two other exceptions that do allow taxpayers to access their retirement funds without the penalty tax deserve closer examination.

The first exception applies only to distributions from qualified retirement plans like profit sharing, 401(k), pension and certain other employer sponsored plans. Under this exception, a taxpayer who has "separated from service" (i.e. they have retired, quit or been laid off) after attaining age 55 may withdraw any amount from his or her employer's plan free of the 10 percent penalty tax.

This exception to the 10 percent penalty rule allows for the greatest flexibility and is very beneficial for many early retirees. It can even be utilized if the taxpayer has left the employ of one employer and makes the withdrawal from that first employer's plan while working as an employee of a second company. For some, it's a good reason to leave their retirement plan balances with their former employer since withdrawals from IRAs (even if the taxpayer is over 55 and not working) will not qualify for this exception.

There are, however, disadvantages to this exception. First, former employees are at the mercy of their former employers with respect to their withdrawal rights from the plan. Employer sponsored plans can have a wide variety of withdrawal options, some very liberal and others may be very restrictive. Second, an investor who leaves a former employer also cedes investment control to the former employer.

The other exception to the 10 percent penalty rule applies to all types of retirement plans including IRAs and SEPs. Under this exception, a series of withdrawals that represents "substantially equal payments" over the life of the taxpayer (or joint life with a beneficiary) are penalty free. These substantially equal payments must extend for the longer of five years or until the taxpayer turns 59 1/2 years old. Once that requirement has been satisfied, taxpayers can change the amount they are receiving. If the amount withdrawn is altered, the penalty tax applies retroactively to the first substantially equal withdrawal.

Avoiding the 10 percent penalty for early distributions can mean the difference between a successful and unsuccessful transition into early retirement. The exceptions to the rule discussed here must be considered carefully and incorporated into an over-all investment and financial plan. Because of the importance of the decision and the complexity of the rules, many thoughtful taxpayers consult professional financial planners and tax advisors before making what could be a critical decision.