Are IRA Distributions Taxable If You Are Disabled?

Individual Retirement Accounts (IRAs) offer tax breaks for investors who make income, including those receiving Social Security disability payments. But what about those receiving Social Security disability benefits?

IRS rules define “total and permanent disability” more broadly than are commonly found within LTD insurance plans, which could have an impact on how an IRA distribution is taxed.

Disability Exclusion

IRS rules offer an exemption to the 10% early withdrawal penalty for distributions from an IRA if you’re disabled; however, their definition of disability requires proof.

If you are permanently and totally disabled and receiving either Social Security Disability Insurance or Supplemental Security Income, no early withdrawal penalty should apply to IRA distributions. In addition, this restriction doesn’t apply if money is used for expenses associated with disability such as transportation, employment training and support, assistive technology purchases or upgrades, healthcare preventive management plans or oversight monitoring services.

To claim the disability exclusion, an IRA owner must use code “3,” Disability, in box 7 of IRS Form 1099-R. To meet IRS criteria that someone be totally and permanently disabled, some financial organizations require documentation such as a physician’s statement for documentation of total and permanent incapacity; alternative forms of documentation could suffice such as that provided by long-term disability (LTD) insurance providers.

Early Withdrawal Penalty

IRS rules permit early withdrawals of your IRA funds without the 10 percent penalty if you can prove you’re totally and permanently disabled, such as with a doctor’s statement. It is also possible to use them for health insurance premium payments after losing a job or qualified education expenses; money can even be withdrawn to assist during a federally declared disaster, funeral expenses and so forth.

Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs and Insurance Contracts provides code “3,” Disability as an appropriate withdrawal designation when reporting your IRA distributions. However, financial organizations may require additional documentation to validate that their account owner meets statutory definition of disability.

As opposed to long-term disability (LTD) policies, IRS definition of disability requires you to be incapable of engaging in any substantial gainful activity – therefore making documentation a critical element before withdrawing money from an IRA account.

SSI Disability Benefits

Social Security Administration offers two disability programs to aid disabled adults and children who lack income and resources: Social Security Disability Insurance and Supplemental Security Income. Supplemental Security Income offers assistance for people who have limited financial means.

Unearned income such as money from retirement accounts or investments will not impact SSI eligibility, although you must still report all earnings and income. Furthermore, your condition or circumstances could require updating your SSI application with any relevant updates that might occur.

If you receive Supplemental Security Income benefits and withdraw funds from an IRA, the IRS does not assess a 10 percent early withdrawal penalty; however, you must still report these distributions as income on your tax return.

Roth IRAs are not permitted unless you also receive earned income. A taxable brokerage account, however, allows for greater investment options while meeting SSA income guidelines – this option could help if you want to invest your SSDI payments while receiving disability payments.

Taxes

People with disabilities often receive benefits through Social Security programs, including disability insurance and supplemental benefits. Unfortunately, though, its rules concerning withdrawals from individual retirement accounts (IRA) and penalties can have a devastating effect on those living with disabilities.

Typically, withdrawing funds from an IRA before age 59 1/2 incurs a 10% penalty tax on any earnings-related withdrawals. There are exceptions, however: first-time home purchase (up to lifetime limit of $10,000) and qualified higher education expenses incurred by yourself, your spouse, children and grandchildren can avoid these penalties.

IRS Instructions for Form 1099-R list code “3,” Disability, as a distribution code in Box 7. However, certain financial organizations report purported disability distributions under code “1,” Early distribution with no known exception, and require the IRA owner to file IRS Form 5329 with her tax return in order to claim this exception. In either event, suitable documentation must support any claims for disability distributions made against her account.

Raymond Banks Administrator
Raymond Banks is a published author in the commodity world. He has written extensively about gold and silver investments, and his work has been featured in some of the most respected financial journals in the industry. Raymond\\\'s expertise in the commodities market is highly sought-after, and he regularly delivers presentations on behalf of various investment firms. He is also a regular guest on financial news programmes, where he offers his expert insights into the latest commodity trends.

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