Disability Optional Forms of Distribution

[Guest annabelle]

I have a participant who fits the definition of disabled. The volume submitter plan document allows optional forms of distribution as follows: "1) lump sum or 2) substantially equal monthly, quartly, semi annually or annual cash installments over a period certain that does not extend beyond participant's life..."

At this time he is not sure whether or not he will take a distribution. He wants the option to take a distribution in the future for whatever amount he desires (when the need arises). The options articulated above do not allow this. Can the plan be amended to accomodate this and if so can he still avoid the early distribution penalty?

[QDROphile]

You can amend the plan to allow particpants to use it like a one-way bank.

If the participant uses it like a bank, one wonders if the distribution or distributions would be attributable to disability under section 72(t).

[Belgarath]

QDROphile - what about this would set off the alarm bells for you? As long as the disability qualifies under 72(m)(7), there's no restriction on the timing that I'm aware of. So it's possible that there are other assets, disability pay, spouse working, etc. such that withdrawals might be needed only on occasion. (Although I grant you that the "normal" disability situation I see doesn't work like this.)

[QDROphile]

Let me turn the tables on you. What would link distributions to the disability if the participant took a first distribution three years after becoming disabled and then sporadically took distributions? The statutue does not say distributions while disabled are not subject to the tax. I doubt that the intent was to have a scheme of substantiation like spending accounts or hardship distributions (i.e. proof that the disability caused the need for money). How do you give meaning to the words in the statute? I might be less troubled by the distribution options that are in the plan document even if the start date is later than the disability date. But the bank approach does not seem to connect.

[Belgarath]

I guess we'll just agree to disagree on this one. I think you are reading too much into the statutory language. It only says that the penalty tax will not be imposed for distributions "attributable to the employee's being disabled within the meaning of subsection (m)(7)." Nowhere does it specify a timeframe for the distribution.

So a participant gets in a car accident and is a quadriplegic. But given the other assets/funds available, only needs to draw on the pension sporadically for unexpected expenses.

First, I can't imagine the IRS attempting to assert that the penalty tax was payable, and even if they did, I can't imagine that that they would prevail if someone wanted to take it to Tax Court. Are there any court cases you are aware of that reached an opposite conclusion in a case where the disability is clearly a disability under (m)(7)?

[QDROphile]

At least we can agree that statutes can be worded better. If the intent was to exempt all distributions to a disabled person, then it should say so, rather than "attributable."

If I were to argue your side, I guess you could give meaning to the statute in the situation where the person started installments for a fixed period after termination, then became disabled. The distribution would in no way be attributable to the disability, and would be subject to the penalty. But then what would you do with banking options? Sporadic distributions before disability would be taxable and those afterward would not? Under your interpretation, if a disabled person needs money, then the distribution is "attributable." I can't prove you wrong.

[Guest annabelle]

Statutory construction dictates that we read what a statute says on its face -- not what it does not. A judge will not read into the statute unless there is blatent confusion and ambiguity as to the meaning. Here it seems pretty straight forward -- distributions attributable to disability are exempted from the penalty. Thus, amending the plan to add another option -- to allow for distributions no less than 10,000 and not to exceed the disabled person's account balance would be an acceptable solution, would it not? Another solution might be taking the lump sum provided by the plan and rolling it over to an IRA...still escaping the penalty.

[Belgarath]

"But then what would you do with banking options? Sporadic distributions before disability would be taxable and those afterward would not?"

Yup.

But I certainly can't prove you wrong either. Hopefully, if the IRS ever opines on this subject, they will take the "kindler and gentler" approach.

Just out of curiosity, do you take your same interpretation on an IRA? The exception there utilizes the same exception under 72(t), but I've never heard of a situation where there was a timeframe enforced whereby the penalty would apply if a disabled person took a distribution after some specified amount of time following actual occurrence of disability. But if you do view them differently, then couldn't the disabled participant then just roll to an IRA and take distributions from the IRA? Thanks for the responses - it's a lot more interesting considering this than mandatory rollovers, which seems to be all I'm doing these days!

[Kirk Maldonado]

I'm sort of in favor of splitting the baby.

I agree with QDROphile that if there is a significant lapse of time between the time of the event and when the distribution occurs, it is hard to argue that the distributions is "attributable" to the disability. My recollection is that there is some guidance from the IRS on this point, possibly relating to hardship distributions of section 401(k) contributions. It might have come in informal guidance given by the IRS to the ABA; I just don't recall at this point in time.

I think that if the test were simply that the onset of the disability must have occurred first, the statute would say that the distributions must occur "after" the person became disabled, along the lines of the exemption from the premature distributions tax in section 72(t)(2) that applies to payments "made to an employee after separation from service after attainment of age 55."

On the other hand, given that the IRS has not yet promulgated any guidance on how long of a delay is acceptable, it is hard to image that the IRS would try to impose an arbitrary limit upon audit. Thus, I think that the risk of the IRS coming after the person who got the distribution is pretty slim.

Finally, it is not good public relations for the IRS to go after disabled persons that take reasonable but (in the eyes of the IRS) incorrect interpretations of the law in the absence of any formal guidance from the IRS on that issue. I don't think that the decision makers at the IRS would make a blunder of that magnitude.