Are Roth IRA Distributions Taxable If You Are Disabled?

Disability payments generally do not count as earned income for purposes of qualifying to contribute to a Roth IRA, although that’s not always the case.

An elderly beneficiary could potentially avoid paying the 10% early distribution penalty by providing evidence to IRS that their condition meets the definition of disability as defined by Social Security Disability Insurance or Supplemental Security Income programs.

Taxes

Dependent upon the type of retirement account and age at which you withdraw funds from it, when withdrawing they may or may not incur taxes. Generally speaking if taking money out before age 59 1/2 is subject to a 10% penalty from the IRS unless there are certain exceptions available.

Disability is among them; if your medical condition prevents you from engaging in substantial gainful activity, the IRS allows distributions from your IRA without penalty; this includes distributions used to cover permanent disabilities or injuries that will last throughout life.

There are also exceptions for buying your first home, incurring high medical expenses or experiencing other unusual events; however, disabled exemption only applies to withdrawals made from your IRA rather than distributions made to others such as spouses or family members. When applying for these exemptions you must provide evidence of your disabling condition.

Withdrawals

If you file for disability and obtain medical proof that your incapacity to perform significant gainful activity has been verified by a physician, the IRS waives its 10-percent withdrawal penalty from traditional IRAs when withdrawing money; however, you will still owe income tax when withdrawing funds from them.

Your traditional IRA allows you to withdraw distributions without penalty for medical expenses that exceed 7.5% of your adjusted gross income, as determined by an IRS-approved calculation that takes into account age and account balance. The distributions should be distributed over your remaining life expectancy using an IRS formula that factors in age and account balance.

Form 1099-R instructions list “3,” Disability, as the appropriate reporting option in Box 7. This method transfers responsibility for claiming disability exemption to financial organizations who must obtain suitable documentation supporting this claim. Regardless of which reporting option you select to report your IRA withdrawals, always consult a trusted tax professional first; your choice could have an effect on whether or not you qualify for Social Security disability benefits or other governmental assistance programs.

Social Security

While IRAs are an excellent way for many to save for retirement, they can have unintended repercussions if you receive Social Security disability benefits. The Social Security Administration may view distributions from an IRA as income that puts someone over the threshold and into Social Security Disability insurance eligibility.

To avoid this scenario, it may be beneficial to utilize a third-party special needs trust (SNT) as a vehicle to hold your IRA funds for you and allow for longer distribution periods of your distributions from it.

However, even this is not guaranteed if the Social Security Administration determines your disability isn’t permanent; therefore it is wise to have proof of disabling condition from an approved healthcare provider uploaded into your IRA dashboard’s secure shared files folder and submitted through Box 7 of Form 1099-R.

Disability

Since Social Security disability programs are income-based, the amount in an IRA or other retirement account could impact how much SSDI you receive. For instance, if your disability status changes and you no longer generate enough work income to qualify for benefits, rules prohibit making contributions or taking distributions until such time that your eligibility changes again.

Eligible recipients of means-tested entitlement programs like Supplemental Security Income or Medicaid must maintain low assets and income levels to remain eligible. Any withdrawals before age 59 1/2 may incur the 10% early distribution penalty; there are exceptions for disability that allow you to bypass this charge.

Some financial organizations avoid code “3” when reporting 1099-Rs for 1099 owners who claim to be disabled; instead they require them to submit documentation through an easy fill-in Physician Statement form in Box 7. This method gives IRA owners more control of their claim to disability-exemption benefits without leaving it up to someone else to make decisions for them.