The Medical Expense Exception for Retirement Plans and IRAs

| May 19, 2016
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If you try to withdraw money from your Individual Retirement Arrangement (IRA) before you reach age 59 ½, you might have to pay an early 10% withdrawal penalty. That’s just the way the rules are written. There are however, certain exceptions from this penalty if you qualify. One of the exceptions is the Medical Expense exception. A lot of people are not sure how this works, so let’s see if we can shed some light on this particular exception.

The Medical Expense exception allows you to withdraw a certain amount of money from your IRA, before age 59 ½, without the 10% early penalty for unreimbursed medical expenses. But there is a calculation you must do first. To find the amount you can withdraw without a penalty, you must look at the excess of your unreimbursed medical and dental expenses over 10% (referred to as the floor) of your adjusted gross income (AGI). Here’s a quick example:

Say your AGI is $100,000, then 10% of that is $10,000. Now assume your unreimbursed medical expenses were $12,000. The excess is $2,000 ($12,000 - $10,000 = $2,000). So the amount you can distribute (or withdraw) from your IRA without the 10% early penalty is $2,000.

Now another thing to be extremely careful about is the timing of your medical expenses and using money from your IRA to pay these expenses. Specifically, expenses must be paid in the same year as the distribution to qualify for the exception to the 10% penalty. This is really important!

To stress the importance of this, let’s look at an example from an actual tax court case:

Jeanette Kimball withdrew about $17,000 from her qualified retirement plan in the year 2000 to pay for medical treatments that began in 2000. However, most of these medical bills were actually paid in 2001. (Expenses were paid in a different year!)
The Kimball’s claimed that since they used the funds for medical expenses, they should get the medical expense exception to the 10% penalty.
They felt they did not owe the 10% penalty assessed by IRS. Guess what?
The IRS disagreed and the Kimball’s ended up in Tax Court where they lost their case. The Court said the medical deduction for a tax year is only allowed for “expenses paid during the taxable year” for medical care, and only “to the extent that such expenses exceed 7.5% of adjusted gross income.”
(Jeanette M. Kimball, No. 16640-02S; Jan. 8, 2004) (The 7.5% has now been increased to 10%)

The lesson to be learned is, if you intend to use the Medical Expense exception, you must pay medical expenses in the same year that the distribution was made from your company plan or IRA. The amount that can be taken penalty free is the amount over 10% of your AGI for unreimbursed medical expenses. The medical expense exception applies to both employer sponsored retirement plans and IRAs. Once again, retirement plan rules are very treacherous and you need to proceed with caution. If you have questions on this topic, feel free to contact us for more information.

Thanks for reading!

The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.

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