People Who Are Disabled and Can’t Work May Tap Into IRA Early Without Penalty

Q I am in my late 30s and suffering from AIDS. My life expectancy is less than three years. May I

withdraw from my individual retirement account without paying a penalty? If so, what forms do I use?

--F.C.

*

A Anyone meeting the government’s definition of disabled is entitled to take funds from his or her IRA, Keogh and 401(k) accounts without paying the typical 10% penalty for withdrawal before turning age 59 1/2. However, you still must pay ordinary income taxes on any portion of those withdrawals not already taxed.

A terminal illness such as AIDS or cancer in an advanced stage would seem likely to qualify on its face as a disability. But you must prove in addition that you are both sick and unable to work in order to tap into your tax-sheltered savings accounts without paying a penalty. (Of course, you may still legally withdraw from these accounts at any time by paying the 10% penalty if you cannot meet the penalty exemption criteria.)

Section 72(t)(m)(7) of the Internal Revenue Code defines “disabled” as “unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment, which can be expected to result in death or to be of long-continued and indefinite duration.” A physician’s certification is usually required to prove your condition to the satisfaction of the authorities.

In general, our experts say, the government has become more compassionate in recent years as the AIDS problem has become more widespread and better understood.

If you can meet the exemption criteria and decide to proceed with the withdrawal, you should notify the financial institution handling your account that you are not subject to the 10% penalty because of your disability. The institution should note the exemption by filling in Box 7 on your 1099R Form with a Code 3. If Code 3 is not checked, you should file IRS Form 5329 to claim the disability exemption from the 10% penalty.

Again, this only entitles you to an exemption to the early withdrawal penalty; you still must pay ordinary income tax on the disbursement in the year you receive it.

You did not ask, but you might be interested in knowing that you also may be eligible to receive disability payments from the Social Security Administration.

Eligibility rules for these payments, as well as additional information of special importance to AIDS patients, are contained in “A Guide to Social Security and SSI Disability Payments for People With HIV Infection.” You may obtain the pamphlet by calling the Social Security Administration at (800) 772-1213.

AIDS Project Los Angeles, which provided much of the information contained here, has staff members and volunteers ready to answer any additional questions you may have about your financial and legal situation. It may be reached at (213) 993-1600. The Southern California AIDS Hotline will also provide assistance. It may be reached at (800) 922-2437.

*

Q My wife died last year, and I must have the properties we jointly owned appraised for estate value purposes. Must I hire professional appraisers?

--K.C.

*

A In most cases, our experts say, taxpayers can get away with valuing their real estate holdings through a written list of recently sold comparable properties in the neighborhood. You may have a friendly real estate broker who will perform this service for you gratis; if not, you can purchase such a list from a qualified broker.

But if your holdings are in any way complicated, you might need the services of a certified appraiser. You will pay for this, but the alternative could be an IRS hassle that would be equally costly and time-consuming.

The real issue here is the motive behind the appraisal.

The higher the appraisal upon the death of the first spouse, the lower the potential taxable gain to the surviving spouse if there is a sale of those properties. You can expect questions if the IRS believes that, upon the death of the first spouse, the properties have been appraised with this in mind. However, if you play it straight, you should have clear sailing no matter what method of property appraisal you use.

*

Q Several years ago I bought a $100,000 annuity that matures later this year. The annuity has earned more than $100,000, an amount on which I will be taxed. I am age 75 and in a high tax bracket. Am I allowed to treat these earnings to 10-year income averaging?

--J.C.

*

A A tax-deferred annuity is not a qualified pension plan. So despite your age, you cannot take advantage of the 10- or five-year averaging available to senior citizens when they take a lump-sum disbursement from these types of pension plans.

In a nutshell, the special 10-year income averaging is available to those who turned age 50 before Jan. 1, 1986. Those who turn 50 after that date are entitled to average the distribution over five years.

Based on what you’ve told us, your investment is simply a common annuity in which taxation on the accumulated interest is deferred until the instrument matures. It looks as though you will owe taxes on your return.

*

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or send e-mail to [email protected]