Are IRA Distributions Taxable If You Are Disabled?
If you are receiving disability benefits from the Social Security Administration (SSA), they may allow you to withdraw from your retirement account without incurring an extra 10% tax penalty. In order to be eligible, your physician must document that you cannot engage in substantial gainful activity due to medically-determined physical or mental impairment that will last at least 12 months or longer.
Taxes on IRA distributions
IRAs are popular investments among those looking to save money and reap tax deductions, while also taking advantage of tax deductions. But people receiving disability benefits from Social Security Administration need to be wary about taking any distributions from an IRA as the SSA views these accounts as financial resources that could reduce or suspend benefits if money from them is taken out.
If you withdraw funds before age 59-1/2 from a retirement plan, in general you will incur income taxes and an early withdrawal penalty of 10% unless an exception applies or you withdraw Roth contributions. Fortunately, total and permanent disability exempts from these penalties.
To avoid incurring the 10% penalty, it is imperative that you file IRS Form 5329 regarding your disability and have documentation from a physician that verifies you are fully and permanently disabled. Custodians do not assess whether you qualify – therefore it’s up to you alone to provide appropriate proof.
Taxes on Roth IRA distributions
If you withdraw Roth IRA earnings before age 59 1/2, taxes will generally apply; with exceptions including purchasing your first home or using them to cover medical insurance during unemployment or cover disability-related expenses.
To qualify, generally you must be disabled. To claim this exception from taxation, the IRS requires proof of your disability; including a written statement from your doctor stating that physical or mental disabilities will prevent them from working for an extended period. Furthermore, to take advantage of it they require Form 5329 with your tax return in order to claim this exception.
Some financial organizations are opting not to use code 3 when disbursing disability-related IRA distributions, instead requiring that their clients file Form 5329 with documentation supporting their claim of disability. Although this approach seems reasonable, collecting all necessary paperwork may still prove challenging and the organization may need to review whether the documentation meets their standards before processing their distributions.
Taxes on traditional IRA distributions
Traditional IRA withdrawals are generally taxed as ordinary income unless you’re age 59 1/2 or withdraw them for a qualifying purpose such as disability payments, first-time home purchases or unreimbursed medical expenses. There are some exceptions to this rule offered by the IRS such as disability benefits or medical expenses not reimbursed by insurers.
In order to qualify for the disability exception to the 10% penalty, you must present a letter from a doctor verifying your incapacity due to injury or illness and its prognosis over an extended period. This definition differs significantly from what the Social Security Administration (SSA) uses as its definition of disability.
Your custodian should send you a 1099-R when taking out a distribution from your IRA, with box 7 for tax penalties checked off if applicable. If so, include a letter from your doctor along with your tax return as evidence that qualifies. It would be prudent to consult a CPA or EA before making decisions concerning retirement savings.
Taxes on distributions from a qualified plan
Many disabled individuals rely on government programs for assistance, including Social Security disability benefits. Withdrawals from an IRA could affect these benefits if distributed funds are used for medical expenses as Social Security counts them as countable income.
Custodians of individual retirement accounts (IRA) typically report distributions using IRS Form 1099-R, which details each dollar distributed and its tax status. Box 7 identifies whether it’s taxable while code 3 indicates whether any disability exception applies (though the IRA owner still needs to file additional paperwork in order to claim it).
To qualify as disabled, one must suffer from either physical or mental impairment that limits any significant gainful activity and impacts their ability to live on their own. As disability definition is stringent, supporting documentation will need to be provided in order to validate your claim.
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