The Internal Revenue Service has special rules for withdrawing money from IRAs in the event you become disabled. Normally, you must pay income taxes and a 10-percent penalty tax on money removed from your traditional or Roth IRA before you reach age 59 1/2. The IRS will lift some of the restrictions for a disability withdrawal as long as a physician certifies your condition as permanent, continuous or terminal. However, the rules are different for traditional and Roth IRAs.
IRA Disability Rules
You must be permanently and completely disabled, according to the IRS definition, to take advantage of IRA disability rules. You must be unable to perform significant gainful activity, meaning you can no longer work enough to earn a living. A physician must certify that the physical or mental impairment is continuous and of long and indefinite duration, or is expected to lead to death.
Withdrawals from Traditional IRAs
When you withdraw funds early from a traditional IRA due to a disability, the IRS waives the 10-percent penalty. However, money taken out of a traditional IRA is still subject to ordinary income taxes. You must report the withdrawal on your tax return and pay taxes due for the year the withdrawal is made.
Simplified Employee Pension IRAs and Savings Incentive Match Plans for Employees are governed by traditional IRA distribution rules. Consequently, a disability withdrawal from a SEP IRA or SIMPLE IRA does not incur the 10-percent penalty, but you still have to pay income taxes on the money withdrawn.
Roth Qualified Distributions
While traditional IRA contributions are often tax deductible, that is not the case with Roth IRA contributions. However, retirement withdrawals from traditional IRAs are subject to income taxes, while Roth IRA withdrawals are tax-free. Withdrawals from a Roth IRA due to a disability may be qualified distributions. "Qualified" means there is no tax liability at all on the funds withdrawn, even if you are not yet 59 1/2 years old. When you make a Roth distribution because you have become disabled, it's qualified if the Roth IRA is at least five calendar years old, counting from Jan. 1 of the year you opened your Roth IRA.
Unqualified Roth Withdrawals
If you make a disability withdrawal from a Roth IRA before the account is five years old, the IRS still waives the 10-percent penalty, but the money you take out might be subject to income taxes. If the withdrawn funds are considered contributed dollars or rollover money, there is no tax liability. You’ll owe income taxes on the withdrawal only if the money you take out counts as earnings. The IRS counts contributions and rollover funds first, so you won’t owe any income taxes on disability-related withdrawals unless the amount you take out is more than the combined total of all contributed funds and rollover money you put into the Roth IRA since you opened it.