What Is the Penalty for Early Withdrawal on Mutual Funds?

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While there is no universal penalty for an early withdrawal from a mutual fund, there are circumstances wherein a mutual fund withdrawal could have financial consequences, including penalties. Depending on the share class purchased, the type of account the fund is purchased in, and other miscellaneous requirements of the mutual fund company, there may be fees attached to mutual fund withdrawals.


Class B Shares

Class B shares represent the mutual fund share class most often associated with penalties for early withdrawal. Unlike other fund share classes, with Class B shares, you only pay a commission when you sell the shares. Known as a contingent deferred sales charge (CDSC), the fee for selling Class B shares normally declines by 1 percent every year and lasts for five or six years, after which there is no charge at all. A typical CDSC might start at 5 percent in the first year and drop to 4 percent in year two, 3 percent in year three, and so on. Thus, if you sell Class B shares in fewer than five years, your CDSC could be considered a penalty for early withdrawal.


Certain Class C Shares

Class C shares, sometimes called "level-load" shares, usually cost 0 to 1 percent to purchase and have higher annual expenses than Class A or Class B shares. At many mutual fund companies, there is no charge to sell Class C shares, but some funds do charge a 1 percent fee for C shares sold within one year after purchase.

Class A shares normally have an upfront sales commission of 3 to 5 percent of the amount invested. Some mutual fund companies allow investors to purchase Class A shares at net asset value (N.A.V.), meaning with no sales charge. Usually, these purchases must be in the amount of $1 million or more. In exchange for the elimination of the sales fee, most fund companies require investors who purchase Class A shares at N.A.V. to keep their money invested for at least one year to avoid an early redemption fee.


Mutual Funds in IRA Accounts

If any mutual fund is purchased in an Individual Retirement Account (IRA), the Internal Revenue Service (IRS) may levy an early withdrawal fee if the funds are distributed from the IRA. Specifically, the IRS imposes a 10 percent early withdrawal penalty on most funds taken out of an IRA before the account holder reaches the age of 59 1/2. If you sell a mutual fund and take a cash distribution of the proceeds before you reach this minimum age, you may be subject to the IRS penalty, in addition to any sales charges levied by the fund company. Exceptions to this rule include distributions for higher education expenses, the first-time purchase of a home or due to disability.


Tax Penalties

If you sell mutual fund shares that you have held for one year or less, any gain you realize on your sale will be taxable at ordinary income tax rates, as opposed to the more favorable capital gains tax rates. As with all investments, those held for longer than one year are taxed at a top rate of 15 percent, as of 2010. If you are in a higher tax bracket, treating your mutual fund as a short-term investment could result in a substantial tax penalty.