Advanced Underwriting Consultants

Question of the Day – November 4

Ask the Experts!

Here’s the question of the day.

Question: I have a 50 year old client who is disabled, and needs to take distributions from his IRA and nonqualified deferred annuity (NQDA) for living expenses.  Are the taxable distributions subject to the 10% penalty tax?

Answer: Distributions from the IRA are probably penalty tax free, while the penalty tax may apply to the taxable NQDA distributions depending on the timing of the disability.

Section 72 of the Internal Revenue Code says that early distributions from an IRA or a NQDA are subject to a 10% penalty tax.  There are also situations where a taxpayer can avoid the imposition of the penalty tax.  The exceptions are listed in Section 72(t) for IRAs, and 72(q) for NQDAs.

Code Section 72(q)(2)(C) says that distributions from a NQDA attributable to the taxpayer’s “becoming disabled” are not subject to the penalty tax.  That differs from the exception language in 72(t), which applies to distributions attributable to the taxpayer’s “being disabled.”

Did Congress mean for the penalty tax disability exception to be different for IRA and NQDA distributions?  For NQDAs, does the disability exception only apply to distributions where the taxpayer became disabled after the contract was purchased?  The IRS hasn’t said for sure.

If the IRS decides to impose a strict interpretation on the NQDA disability exception, then a taxpayer who takes a taxable distribution and who was already disabled at the time of the contract purchase, the 10% penalty tax would apply in most cases.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.