Internal Revenue Code Section 72(t) imposes a 10%-penalty on “premature” distributions from most retirement plans, including 403(b) plans and IRAs. Certain distributions are exempt from the penalty, including those:
- made after attainment of age 59½
- made after attainment of age 59½
- made on account of death;
- due to the participant’s or account owner’s disability;
- part of a series of substantially equal periodic payments; and
- made after an employee separates from service in the same year as attainment of age 55 or later (not applicable to IRAs.
There are additional exemptions, but this article is concerned with the definition of disability. Questions frequently arise, such as: “I’m working with a participant who is not working and receiving long-term disability payments, does that qualify as an exception?” and “I’m receiving Social Security disability payments, does that qualify?”
The answer is, “not necessarily,” because the definition of disability under Section 72(t) may differ from a private disability policy or even from Social Security. Section 72(t) refers us to Section 72(m)(7) for the definition of disability. That section states, “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 . . .”
In May 2009, the IRS provided a bit more guidance. In Chief Counsel Advice 200922041, it established that in order to be considered disabled, the individual has to establish that she was not able to work in the year of the distribution at an activity comparable to the one in which she would customarily engage. Also, the impairment cannot be diminished, given reasonable effort and safety to the individual, to the extent that it will allow the individual to engage in his customary or any other comparable substantial gainful activity.
Additionally, the disability cannot be a temporary one; it must be one that "can be expected to result in death or to be of long-continued and indefinite duration.”
This is similar to, but not identical to the Social Security definition. Here is how the Social Security Administration describes it in their publication on “Disability Benefits”:
Social Security pays benefits to people who can’t work because they have a medical condition that’s expected to last at least one year or result in death. Federal law requires this very strict definition of disability. While some programs give money to people with partial disability or short-term disability, Social Security does not.
So where does that leave us? The simplest answer is to have a physician certify a disability using the language of Section 72(m)(7) above. However, there is also a case in which the Tax Court held that receiving Social Security disability benefits was sufficient proof of a disability as long as the Social Security application was filed before the distribution date. In this case, Dart v. Commissioner, T.C. Summary Opinion 2008–158, the court commented, “Generally, it is intended that the proof of disability be the same as where the individual applies for disability payments under Social Security.” While that sounds promising, Tax Court comments may not be used as precedent for any other case. So the physician certification remains safest.
David R. Blask, CPC, TGPC, AIF®, is Senior Pension Consultant, Lincoln Investment Planning.
Opinions expressed are those of the author, and do not necessarily reflect the views of NTSA, or its members.