Disability and Retirement
(Page 2 of 2 of Getting Your Retirement Money Early -- Without Penalty)
If you become disabled, all subsequent distributions from your retirement plan are free of the early distribution tax. But what does it mean to be disabled? And who decides? The law defines disabled as the inability 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." Hmmm.
The key to the disability exception seems to lie in the permanence of the condition, not the severity. Disability exceptions have been denied for chemical dependence and chronic depression, even when the taxpayers were hospitalized for those conditions. It also appears that the disability must be deemed permanent at the time of the distribution -- regardless of whether it is later found to be permanent. For example, the IRS denied the exception for one taxpayer whose disability was not deemed permanent at the time the distribution was paid -- even though the taxpayer later qualified for Social Security disability benefits because the disability was ultimately determined to be permanent.
If you receive a refund of a contribution to your retirement plan because you contributed more than you were permitted to deduct during the year, those "corrective" distributions will not be subject to the early distribution tax, although they might be subject to other taxes and penalties. In order to avoid the early distribution tax, the excess must come out of the plan within a prescribed time -- usually before you file your tax return. Corrective distributions are usually handled by the plan administrator.
For a complete guide to making sense of the rules that govern distributions from retirement plans, see IRAs, 401(k)s & Other Retirement Plans: Taking Your Money Out, by Twila Slesnick and John C. Suttle (Nolo).
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