Navigating IRA Disability Distributions
By Jennifer Bassett, CIP, CISP, CHSP, QKA
Is disability an exception to the 10 percent early distribution penalty tax?
Yes. A distribution made by an IRA owner who is totally and permanently disabled is not subject to the 10 percent early distribution penalty tax. Internal Revenue Code Section 72(m)(7) states that an IRA owner is disabled if he cannot engage in any substantial gainful activity because of any physical or mental impairment that can be expected to result in death or to be of long-continued and indefinite duration.
Are there special reporting requirements for disability distributions?
Yes. Financial organizations that feel comfortable reporting a distribution as a disability distribution should enter code 3, Disability, in Box 7 of Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.
If an organization does not feel comfortable using code 3, it could use code 1, Early distribution, no known exception, to report the distribution. The IRA owner could then file IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, with her tax return to show that she does have a penalty tax exception.
Is our financial organization required to get proof of disability?
No. If an IRA owner requesting an IRA distribution claims to be disabled, your financial organization should verify this, but is not required to. To ensure accurate reporting, your organization could require IRA owners to provide the fill-in-the-blank “Physician’s Statement” that is found in the Instructions for Schedule R (IRS Form 1040), Credit for the Elderly or the Disabled. The Physician’s Statement contains language addressing the “total and permanent” disability requirement, so getting a medical provider to complete this form and submit it to the financial organization should prove to the IRS that code “3” was the proper code to use.
According to IRS Publication 524, Credit for the Elderly or the Disabled, veterans can also prove total and permanent disability by providing financial organizations with VA Form 21-0172, Certification of Permanent and Total Disability. An authorized person from the Department of Veterans Affairs (VA) must sign this form. Veterans can get this form from their local VA regional office.
Can our financial organization rely on a letter from the Social Security Administration when verifying disability?
No, not when verifying whether an IRA owner has a penalty tax exception. The final RMD regulations provide a safe harbor for determining if a beneficiary is disabled, and can therefore be treated as an eligible designated beneficiary. The safe harbor will apply if, as of the date of the IRA owner’s death, the Commissioner of Social Security has determined that the beneficiary is disabled. There is currently no guidance stating that this form of verification is available to IRA owners.
