If life hands you a lemon in the form of a disability, you’ll quickly discover there is help available, starting with Social Security Disability Insurance and assistance from agencies such as your state department of vocational rehabilitation. Acquiring a disability can still be financially devastating. You might need to tap into your IRA to keep your financial ship afloat.
Distribution for Disability
Early distributions from IRAs will usually earn you a 10 percent penalty on top of ordinary income taxes on the money withdrawn. That's because the Internal Revenue Service gets upset if you take cash from an IRA before you turn 59 1/2. The IRS will waive the 10 percent penalty if you become disabled. You still owe ordinary income taxes unless the withdrawal meets the requirements to be considered a qualified distribution.
A temporary disability does not qualify for a waiver of the 10 percent penalty on early withdrawals from an IRA. The IRS says the disability must keep you from performing substantial gainful activity, meaning you can’t work enough to earn a decent living. The disability must be expected to lead to death or to be of indefinite duration.
If a Roth IRA has been open for less than five years, counting the year you opened the account, withdrawals of earnings or rollover funds are non-qualified distributions. Even if you become disabled, you still have to pay ordinary income taxes on money withdrawn, but the penalty tax will be waived. Once the five year rule is met, any withdrawal made because you have a disability is a qualified distribution and you won't owe a dime in taxes.
Dealing with a disability may force you to tap your IRA, but there are some factors you should think about as you decide how much to withdraw and when to take the money out. The longer you can leave funds in the IRA, the better. That’s because the money in your IRA keeps on earning tax-deferred income until it is withdrawn. Taking out part of the money each year for several years may keep you in a lower tax bracket, so you end up giving less to Uncle Sam. Finally, if your account is a Roth IRA that is less than five years old, delaying withdrawals as much as you can until the five year mark will definitely save you money since you won’t owe any tax at all on withdrawals made after that point.