Todd,
Yes, death and disability are the only exemptions to completion of a 72t plan to it’s regular modification date. Following is a copy of the code provision:

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(4) Change in substantially equal payments
(A) In general
If –
(i) paragraph (1) does not apply to a distribution by reason of paragraph (2)(A)(iv), and
(ii) the series of payments under such paragraph are subsequently modified (other than by reason of death or disability) –
(I) before the close of the 5-year period beginning with the date of the first payment and after the employee attains age 59 1/2 , or
(II) before the employee attains age 59 1/2 , the taxpayer’s tax for the 1st taxable year in which such modification occurs shall be increased by an amount, determined under regulations, equal to the tax which (but for paragraph (2)(A)(iv)) would have been imposed, plus interest for the deferral period.
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It does not matter that the disability occurred before or after the plan start date. She can definitely stop the 72t distributions immediately, and she can also roll back any 72t distributions she has received in the last 60 days as long as her one rollover per account is still available. She should provide documentation of the disability award to her IRA custodian and ask that they change her 1099R coding to a Code 3 (Disability). This should eliminate the need to explain the modified plan to the IRS.

As you know, 72t plans are rigid and prone to error, so she should keep this documentation in the event that the IRS finds something wrong with her calculations when the plan started in 2007. She would then have the disability award retroactive date to fall back on that would waive the penalty for any errors that may have been committed in executing the 72t plan.

Note that a SS disability award is technically not fully conclusive to meeting the total disability requirement under the tax code. There is a possibility, however remote, that the IRS could question it, particularly if the custodian does not provide the disability coding on the 1099R and custodians have some peculiar procedures in handling 72t related coding issues. So if there is any question based on the nature of her disability, she should get some MD statements that she meets the total disability definition posted below, particularly if the “any gainful activity” potential exists:
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Q. What is the Definition of Disability for 72(t)??
A. The definition of disability can be found in IRC Section 72(m)(7). In one case,Dwyer v. Comm., 106 TC No. 18 (1996), the Tax Court agreed with the IRS and stated…

For purposes of this rule, an individual is considered 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 infinite duration.” The Code specifies that an individual must be able to furnish proof of his disability in whatever form and manner that the Service may require. The court noted that the regulations under Section 72 also state that an impairment that is remediable does not constitute a disability.
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1) I meant that the 1099R coding should be changed in the future, including the 2010 1099R not yet issued. It is not necessary that already issued 1099R forms be revised. Client should just keep all the documentation. But she should push the custodian for a comittment to Code future 1099R with the 3 code as that will be helpful, although not critical in heading off an IRS inquiry when she modifies the 72t plan early.

2) Getting the letter will be a great help, particularly if accompanied with a successful SS disability filing. Providing the letter and/or other evidence to the custodian to get the 3 coding is also very helpful. A client will be reasonably home free if they have all 3 (Disability award, coding and letter), are still on reasonably solid ground with 2 of 3, and may not be questioned with just one of 3. Each adds another layer of protective documentation to head off any IRS inquiry in the first place and to satisfy the IRS in the event they do inquire.

3) The one 60 day rollover applies per IRA account over a 12 month running period, and also to an IRA that receives a rollover. Anyone with a 72t plan should preserve their rollover as insurance against a distribution error. If they take out too much for a year due to an error and discover this when doing a final plan check in December, they can roll back any distribution they received within 60 days. A SEPP payment cannot be rolled over, but amounts in excess of the annual requirement are not deemed to be SEPP payments. 72t participant should generally limit changes of custodians, but if they have a reason to make the change, it is best to do it by direct transfer since a direct transfer is not reportable and it also saves the one rollover for an emergency need. Rollovers to or from a qualified plan or Roth conversions do not count against the one rollover limit.

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If the client meets the definition of “disabled” (see details of earlier post in this thread), then the 72t plan ended on the date of the disability. All distributions would be coded with the disability code 3 or if not could be changed by filing a 5329 with exception code 03. This would tell the IRS that the 72t plan had terminated and therefore could be modified in any way the IRA owner wanted.

If he then took out a large lump sum, there would be no penalty but of course ordinary income taxes would apply.

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