Are IRA Distributions Taxable If You Are Disabled?
Distributions made prior to age 59 1/2 can incur a 10% penalty tax; one exception includes disability.
To qualify for the disability exception, you must present a doctor’s statement certifying your condition as incapacitating and likely lasting longer than six months.
Disability is a condition that prevents you from engaging in any substantial gainful activity.
SSA defines disability as being incapable of engaging in any substantial gainful activity (SGA), so when considering eligibility for disability benefits it’s essential that disabled individuals subtract income from total earnings in order to lower the countable earnings and improve chances of meeting the SGA threshold.
If you withdraw from your IRA prior to reaching age 59 1/2, in general a 10% penalty plus ordinary income tax applies; however there are exceptions such as buying your first home, emergency personal expenses and more.
Because each financial situation differs, you should consult a U.S. Bank tax or legal advisor before taking any steps regarding your IRA. For more information about IRAs in general, see IRS Publication 590-A; for those named beneficiaries of an inherited IRA account, you can also read our blog post regarding how these accounts are taxed.
You’re unable to do your own occupation.
The tax code defines disability as being unable to engage in any substantial gainful activity due to physical or mental impairment that’s expected to last indefinitely or result in your death. This definition can be restrictive; it doesn’t imply having to change careers because of an injury, or retiring early due to medical conditions.
If you have a disability, one way to sidestep the 10% early distribution penalty tax may be taking advantage of one or more exemptions to this rule – including first-time home purchases, qualified education expenses or medical costs.
As part of your required minimum distributions (RMDs), qualified charitable distributions (QCDs) from an IRA allow for penalty-free withdrawals to cover health insurance premiums or funeral costs. These distributions count towards fulfilling RMD requirements.
You’re unable to do any occupation.
Many people depend on IRA distributions to cover unreimbursed medical expenses, a first-time home purchase and qualified higher education costs for themselves and family members. But early withdrawal can come with penalties: typically 10% penalty tax is assessed for early distributions (refer to IRS Publication 590-B for more details).
To be eligible for an exemption from tax penalties, one must meet the Internal Revenue Service definition of disabled and obtain a doctor’s opinion that you are expected to be unable to work any occupation. This standard can be very stringent.
Financial organizations can avoid this penalty by using code 3 on Form 1099-R to report disability distributions. They may request documentation proving they meet the statutory definition of disabled. Some financial organizations will ask medical providers to fill in a Physician’s Statement provided with Instructions for Schedule R; but other forms of diagnosis documentation will suffice as well.
You’re unable to perform any substantial gainful activity.
The IRS allows a few exceptions from its 10% additional early withdrawal penalty, including one for disability. However, its definition of disability can be more stringent than what Social Security Administration uses and can make compliance challenging.
Under the tax code, disability refers to any condition which prevents you from engaging in substantial gainful activity for an indefinite duration, including that which causes death. A TDIU rating from the VA does not automatically qualify you for this exemption.
If you think you qualify for the disability exception when withdrawing funds from an IRA or pension plan, make sure to enter Code 3 into Box 7 on Form 1099-R (or TaxSlayer Pro software program), and follow its instructions for claiming this exemption. Be sure to also consult a tax professional as they can assess your unique circumstances and guide you accordingly.
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