Unemployment hardship withdrawal
I have a 49-year-old client who received unemployment compensation for twelve consecutive weeks in both 2010 and 2011. He also paid medical insurance in both of those years and is not yet reemployed. The hardship rules for IRA distributions seem to say that distributions up to the amount paid for medical insurance can be taken without penalty as long as they are taken either in the year the unemployment compensation was received, or in the following year. He would like to take the distributions for both 2010 and 2011 now, but his CPA claims that its too late for the 2010 distribution and only the 2011 distribution will be penalty free. He cites the IRS’s “cash basis” rule as it applies to income tax obligations as the reason. Does anyone have a different answer? Thanks.
Permalink Submitted by Alan Spross on Tue, 2011-08-02 17:38
The following is a copy of the penalty exception:
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72(t)(2)(D) DISTRIBUTIONS TO UNEMPLOYED INDIVIDUALS FOR HEALTH INSURANCE PREMIUMS. —
72(t)(2)(D)(i) IN GENERAL. –Distributions from an individual retirement plan to an individual after separation from employment —
72(t)(2)(D)(i)(I) if such individual has received unemployment compensation for 12 consecutive weeks under any Federal or State unemployment compensation law by reason of such separation,
72(t)(2)(D)(i)(II) if such distributions are made during any taxable year during which such unemployment compensation is paid or the succeeding taxable year, and
72(t)(2)(D)(i)(III) to the extent such distributions do not exceed the amount paid during the taxable year for insurance described in section 213(d)(1)(D) with respect to the individual and the individual’s spouse and dependents (as defined in section 152, determined without regard to subsections (b)(1), (b)(2), and (d)(1)(B) thereof).
72(t)(2)(D)(ii) DISTRIBUTIONS AFTER REEMPLOYMENT. –Clause (i) shall not apply to any distribution made after the individual has been employed for at least 60 days after the separation from employment to which clause (i) applies.
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The 2011 IRS distribution will be taxable in 2011 but suffix (II) above allows the penalty to be waived to the extent of premiums that were paid in 2010 if 12 weeks of UC was collected in 2010. If the CPA’s reference to “cash basis” rules relates to the taxable year when funds change hands, there is no conflict because the distribution will be taxed in the year distributed (2011). But the penalty will be waived under the provision above because it can be applied to premiums paid in 2010 (ie distribution taken in the succeeding taxable year of 2011).
Since 12 weeks of UC were also collected in 2011 and the 2011 premiums were paid in 2011, another IRA distribution either in 2011 or 2012 can be taken with a penalty waiver as well. The federal extensions of UC benefits likely set up this situation where the same period of unemployment extends over two different calendar years. Therefore two years of premiums are eligible expenses for the penalty waiver with a two year window applying with respect to when the IRA distributions are made. I see no problem with the 2010 expenses being covered by a 2011 distribution and also the 2011 expenses with a 2011 distribution. Obviously, the same expenses (premiums) cannot be used for a penalty waiver on distributions that exceed those premiums.
Also, premiums used for this particular waiver cannot also be used for the more general unreimbursed medical expenses in excess of 7.5% of AGI. That would be double dipping using the same expenses for two different 72t waiver provisions.
Permalink Submitted by Russ Rauhauser on Tue, 2011-08-02 18:22
Thanks very much, Alan. Your answer makes sense to me. The CPA’s interpretation did not.