The ERISA consultants at the Learning Center Resource Desk, which is available through Columbia Threadneedle Investments, regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. A recent call with an advisor in Maryland is representative of a common inquiry regarding penalty exceptions for early distributions from retirement accounts. The advisor asked:
“How does the IRS define disability for the purposes of allowing a 401(k) plan participant to take a distribution before the age of 59½ without a penalty tax?”
Generally, amounts an individual withdraws from an IRA or retirement plan before reaching age 59½ are called ”early” or ”premature” distributions. Beyond including the pretax portion of an early distribution in taxable income for the year taken, the recipient must pay an additional 10% early withdrawal penalty tax, unless an exception applies [Internal Revenue Code Section (IRC §) 72(t)].
There are several exceptions to the early withdrawal penalty tax found in IRC §72(t)(2)(A)-(G), including an exception for disability (IRC §72(t)(2)(A)(iii). The IRS defines disability for this purpose in IRC §72(m)(7), and the definition is quite strict:
“… an individual shall be considered to be disabled if he is unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment which can be expected to result in death or to be of long-continued and indefinite duration. An individual shall not be considered to be disabled unless he furnishes proof of the existence thereof …”
Some disabled individuals file IRS Schedule R, Credit for the Elderly or Disabled, with their IRS Form 1040s. The schedule requires a physician’s certification that a person meets the IRC §72(m)(7) definition of disabled. Alternatively, a physician’s signed statement attesting to an individual’s permanent and total disability can serve as proof of the condition.
See the IRS publication, Retirement Topics - Exceptions to Tax on Early Distributions, for other penalty exceptions.
Conclusion
While disability can qualify a distribution recipient for an exception to the early withdrawal penalty tax, the definition of disability for this purpose is rigorous and requires proof.
The Learning Center Resource Desk is staffed by the Retirement Learning Center, LLC (RLC), a third-party industry consultant that is not affiliated with Columbia Threadneedle. Any information provided is for informational purposes only. It cannot be used for the purposes of avoiding penalties and taxes. Columbia Threadneedle does not provide tax or legal advice. Consumers consult with their tax advisor or attorney regarding their specific situation.
Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed by Columbia Threadneedle.
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