In January 2014, when Secretary Perez hosted a roundtable with long-term unemployed individuals affiliated with job clubs in MD, VA, and NJ, he heard firsthand about the practice of long-term unemployed individuals taking early withdrawals from their 401k or IRA retirement savings plans. Long-term unemployed individuals were required to pay the additional 10 percent tax penalty for early withdrawals after unemployment insurance benefits expired and other forms of savings were exhausted. The need to pay for basic necessities for themselves and their families outweighed the deterrent effect of the early withdrawal penalty.
We have heard similar stories from job clubs and long-term unemployed individuals nationwide. Such input has led to a key proposal in the fiscal year 2016 budget: expanding penalty-free withdrawals for the long-term unemployed.
The budget proposal, which needs to be passed by Congress in order to become law, is spelled out in detail in the Treasury Department's "Greenbook" of Fiscal Year 2016 Revenue Proposals. Here is language from the proposal:
EXPAND PENALTY-FREE WITHDRAWALS FOR LONG-TERM UNEMPLOYED
Early withdrawals from a tax-qualified retirement plan or IRA are subject to a 10-percent additional tax, unless an exception applies. An individual is eligible for an exception from the 10-percent additional tax with respect to a distribution from an IRA after separation from employment if (1) the individual has received unemployment compensation for 12 consecutive weeks by reason of the separation from employment, (2) the distribution is made during the taxable year in which the unemployment compensation is paid or in the succeeding taxable year, and (3) the aggregate of all such distributions does not exceed the premiums paid during the taxable year for health insurance. A distribution that is made after an individual has again been employed for at least 60 days is not eligible for this exception from the 10-percent additional tax.
There is no corresponding exception from the 10-percent additional tax for distributions from a qualified retirement plan by reason of a period of unemployment. The fair market value of an individual’s IRA is reported to the IRS as of the end of each year on Form 5498. No similar reporting is required with respect to the fair market value of an individual’s account balance in a tax-qualified defined contribution plan.
Reasons for Change
Because unemployment compensation is available only for a limited period, some long-term unemployed individuals may have no choice but to take distributions from an IRA or tax qualified retirement plan to pay for basic necessities for themselves and their families. Although the 10-percent additional tax is intended to deter individuals from using retirement savings for purposes other than retirement, imposing the additional tax on distributions to a long-term unemployed individual further erodes the limited resources available to the individual without having a substantial deterrent effect.
The proposal would expand the exception from the 10-percent additional tax to cover more distributions to long-term unemployed individuals from an IRA (in excess of the premiums paid for health insurance) and to include distributions to long-term unemployed individuals from a 401(k) or other tax-qualified defined contribution plan. An individual would be eligible for this expanded exception with respect to any distribution from an IRA, 401(k), or other tax-qualified defined contribution plan if (1) the individual has been unemployed for more than 26 weeks by reason of a separation from employment and has received unemployment compensation for that period (or, if less, for the maximum period for which unemployment compensation is available under State law applicable to the individual) (an eligible individual), (2) the distribution is made during the taxable year in which the unemployment compensation is paid or in the succeeding taxable year (which allows for distributions over the same two-year period applicable under current law), and (3) the aggregate of all such distributions does not exceed the annual limits described below.
To read the full proposal, see page 138 of this document:
Modified On : February 16, 2015
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