If You Have a Disability, You May Be Able to Avoid IRA Early Withdrawal Penalties
More and more companies are jettisoning traditional pensions in favor of Individual Retirement Accounts, 401(k)’s and other profit-sharing arrangements. Most of these plans allow an employee to shelter his retirement savings, tax-free, until retirement. When an employee withdraws funds from his IRA or 401(k), the amount withdrawn is considered taxable income. Because of this favorable tax treatment, the government does not want people to remove the funds from a retirement account until they reach retirement age, so it imposes an additional 10 percent tax on any funds that are taken out of an IRA or 401(k) before the owner of the account is 59 1/2 years old.
The early withdrawal penalty has been very effective at forcing retirement plan owners to keep money in their retirement accounts, but it could be unnecessarily punitive if an employee suddenly becomes disabled and needs to access the funds in his retirement account to pay for medical expenses or for the daily cost of living. The IRS has taken this problem into account and offers people with disabilities, or people who incur sudden medical expenses, a break.
If a retirement account owner becomes disabled, the IRS will waive the 10 percent early withdrawal penalty so long as she can show that she is unable to perform any substantial gainful activity and that the condition causing the disability is expected to result in death or last for a long time. These requirements just so happen to mirror some of the major requirements for a person to qualify for Social Security Disability Insurance (SSDI). If the account owner meets this stringent medical requirement, she can take the funds out of her retirement account and avoid the 10 percent penalty. However, she will still have to declare the withdrawal as income on her yearly tax return.
If someone does not meet the disability requirement, there are still several other exceptions to the early withdrawal penalty that may be useful for a person with a disability, even if his condition does not rise to a level where it completely prevents him from performing substantial gainful activity. If someone is unemployed and needs to take money out of a retirement plan to pay privately for health insurance (often very important for people with disabilities or for the parents of children with disabilities), the IRS will waive the early withdrawal penalty. Likewise, if an account owner has significant unreimbursed medical expenses that are more than 7.5 percent of his gross income, then the retirement funds can be utilized to pay for those bills without penalty.
While the disability, health insurance and medical expense exceptions to the early withdrawal penalty are probably the most pertinent for people with disabilities, there are several other exceptions, like an exception for higher education expenses, that may also meet a family’s needs. If you need to access the funds in your retirement account but are worried about the penalties associated with an early withdrawal, talk to your special needs planner to see if you fit one of the exceptions. You could be able to do more with your retirement funds than you think.