Waiver of 10% penalty for Disability

[Jennifer D.]

We have a participant who terminated from a plan who is under age 59.5. At the time of termination the participant did not take out heir money. The participant is now disabled and would like to make a withdrawal. Would we waive the 10% penalty for this person even though they were disabled after termination?

[GMK]

According to:

http://www.irs.gov/pub/irs-prior/i5329--2013.pdf (page 3),

the additional tax on early distributions does not apply to "Distributions due to total and permanent disability. You are considered disabled if you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long, continued, and indefinite duration."

If the distribution is being made due to the participant's total and permanent disability, then the IRS waives the 10% penalty, and the plan puts a 2 in box 7 on the 1099-R (under 59-1/2, no penalty) in this case. Otherwise, it's a 1 in box 7.

[John Feldt ERPA CPC QPA]

It's the IRS that waives the penalty. Even if the normal distribution code is used on the Form 1099-R, the participant can attach a schedule to their 1040 to claim that they are exempt from the excise tax. If you are the payor of the benefit, I do not think you are required to determine whether or not the 10% penalty exemption applies.

[david rigby]

From the facts presented, the participant became disabled after severance of employment. If the participant's ability to take a distribution was the same before and after the incidence of disability, then it seems unlikely the participant could claim the distribution is "due to" disability.

[John Feldt ERPA CPC QPA]

Regardless, the 10% penalty exemption can apply by attaching the proper schedule to the 1040. The 10% is not assessed or even withheld by the payor.