How Do Distributions from Retirement Accounts Respond to Early Withdrawal Penalties? Evidence from Administrative Tax Returns

The design of retirement savings accounts must balance the long-term goal of retirement wealth accrual with the potential need for liquidity in the short-term. Penalties on pre-retirement withdrawals provide a possible lever for striking this balance. In the United States, penalties are typically limited to 10 percent of withdrawn funds and several exceptions are available in order to provide access to savings in response to a shock. In this paper, we investigate how individuals respond to the removal of the 10 percent penalty imposed on Individual Retirement Account (IRA) withdrawals prior to the account holder turning 59.5. Our analysis employs rich tax records from the Internal Revenue Service (IRS) and develops new empirical techniques which allow us to use annual data to better understand movements at higher levels of frequency. Our findings show evidence of a 93 percent increase in annual withdrawals on average among our population, and suggests that much of this increase in withdrawals is coming from new people making withdrawals once they cross the age 59.5 threshold.