72-T and Disability

Submitted by Duncan Financial on Wed, 2017-09-13 18:59

I have a client who is taking distributions under IRC 72-t. She became disabled due to liver disease. The coding was changed to early exception disability now she received a liver transplant, is back to work, and no longer on disability. How do I handle her 72-t distribution moving forward? She is 57 years old.



Submitted by Alan - IRA critic on Wed, 2017-09-13 19:23

If the IRA custodian accepted her medical condition as qualifying for the disability code 3 on the 1099R, her 72t plan ended at that time without penalty, and she no longer has a 72t plan or any of the plan restrictions. If she still needs penalty free IRA distributions and the code 3 is no longer approved, she would have to start a new 72t plan. Perhaps with only 2 years to 59.5 and being back to work, this can be avoided. Note that the definition of disability is per Sec 72(m)(7) for both 72t plans AND for 1099R coding. 

Submitted by David Mertz on Wed, 2017-09-13 20:33

Although it might not be relevant in this case, what if the annual payment amount was never changed as a result of being disabled?  With no modification of the SEPP, it seems that the 72(t) plan would still be in effect.  As I read it, if one busts the plan as a result of becoming disabled one is simply exempt from the 10% recapture.

Submitted by Alan - IRA critic on Thu, 2017-09-14 00:21

  • I agree, this is a very rare situation.  If the client continued the 72t distributions despite the disability with the code 3 1099R, the plan would continue unmodified. That would provide insurance in the event that the disability was reversed as in this case or if the IRS found that the code 3 was assigned in error. The original plan would continue and become subject to being busted later on for other reasons, so continuing the same distributions also has it’s risks. Of note, there would be no 5329 filed with a code 3 since the form is only designed to  either pay the penalty or claim an exception to Code 1.  Therefore. the IRS would not receive an annual reminder that the taxpayer maintained a continuing 72t plan. 
  • Suppose the client HAS continued the 72t distributions to date, but has now returned to work and no longer needs the distributions. Changing or stopping the distributions now would bust the plan since presumably the client is no longer disabled under the definition and the code 3 will be changed to code 1. 
  • In summary, client could have busted the plan without penalty up to the day in which she is deemed to no longer be disabled and 1099R distributions would thereafter be coded 1. After the disability ended busting the plan would result in retroactive penalty and interest for all distributions not coded 3, and a new plan would be required to start and run for 5 years unless client was paying off medical expenses which have their own penalty exception.

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