Have a Disability? Avoid IRA Early Withdrawal Penalties

More and more companies are jettisoning traditional pensions in favor of Individual Retirement Accounts (IRAs), 401(k)s, and other profit-sharing arrangements. Most of these plans allow an employee to shelter their retirement savings, tax-free, until retirement.

When an employee withdraws funds from their IRA or 401(k), the amount withdrawn is considered taxable income.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 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 effective at forcing retirement plan owners to keep money in their retirement accounts. However, it could be unnecessarily punitive if an employee suddenly becomes disabled and needs to access the funds in their retirement account to pay for medical expenses or for the daily cost of living. The IRS has taken this problem into account and offers individuals 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 the account owner can show that they are 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 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, they can take the funds out of their retirement account and avoid the 10 percent penalty. However, they will still have to declare the withdrawal as income on their yearly tax return.

Other Exceptions

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 their condition does not rise to a level where it completely prevents them 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 premiums (often 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 their gross income, then the retirement funds can be utilized, penalty-free, to pay for those bills.

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 qualified higher education expenses or for victims of domestic abuse, that may also meet one's needs.

If you are looking to withdraw money from your retirement account but are worried about the penalties associated with an early withdrawal, talk to a local special needs planner to see if you fit one of the exceptions. You may be able to do more with your retirement funds than you think.

A Note for Recipients of Supplemental Security Income (SSI)

Keep in mind that withdrawing funds from an IRA or other qualified plan can have significant implications for someone receiving Supplemental Security Income (SSI) benefits. SSI is a needs-based program designed to provide financial assistance to individuals with limited income and resources. When an individual withdraws money from their IRA, that amount is considered income for the month in which it is received.

This increase in income can push the recipient's total earnings above the SSI income limit, which is set by the Social Security Administration. If their income exceeds this threshold, they may experience a reduction in their SSI benefits or, in some cases, lose eligibility altogether. This can create a precarious financial situation, as the individual may have relied on those benefits for essential living expenses such as housing, food, and medical care.

Additionally, SSI has strict resource limits. If the withdrawn funds are not spent within the month they are received, they may count as resources in the following month. The resource limit for SSI is generally $2,000 for individuals and $3,000 for couples. If the balance in their bank account exceeds these limits, they could face a suspension of their benefits until their resources fall back below the threshold.

It is crucial for individuals in this situation to carefully consider the potential consequences and explore alternative options for financial support before making a withdrawal. Consult with a local special needs planning attorney for guidance tailored to your specific circumstances.

For additional reading related to retirement accounts and individuals with disabilities, check out the following articles:

• Is It Possible to Put a Retirement Plan in a Special Needs Trust?
• Beneficiary Designations Can Cause Problems for Children With Special Needs
• Is an Inherited IRA for a Special Needs Trust a Good Idea?
• What You Should Know About Required Minimum Distributions (RMDs)