Exception 10% Penalty / 401K - Health Ins Prem while unemployed??

[bbrownatl]

I have a client that pulled $5K out of their 401K after losing their job to pay for health insurance. Any way to not pay the 10% penalty. I know what the guidance states regarding the exceptions. Seems that if they took the distribution from their IRA then they would have avoided the 10% penalty but the 401K is more restrictive. Any consideration to not applying the 10% penalty and include a statement with the return that this was used for the family health insurance premiums while unemployed or is this crazy thinking.

The IRS already gives the provision for IRA distributions (i.e. unemployed and received unemployment comp for 12 mos). Just not for 401Ks. I’m just searching. Any thoughts or again, crazy thinking?

[Bees Knees]

The exception for IRAs is IRC §72(t)(2)(D) which says in part...."distributions from an individual retirement plan after separation from employment..."

The IRS interprets individual retirement plan to mean an IRA. A 401(k) is not an individual retirement plan or IRA. Thus a distribution from a 401(k) does not qualify for the unemployed health insurance exception.

Having said that, there is a simple way to have this exception apply. Since the taxpayer is unemployed, that means the taxpayer separated from employment, which gives the taxpayer the right to roll over his/her 401(k) into an IRA. Once the funds are in the IRA, the taxpayer can take a distribution from the IRA to pay health insurance and use the section 72(t)(2)(D) exception to avoid the 10% early withdrawal penalty.

[bbrownatl]

Bees, you are all over it. Much thanks. Yep, that would have been the way. Unfortunately, this is a new client this year and they did take the distribution from their 401K . So, to my knowledge, I think they must pay the 10% penalty as I don't see them qualifying for any of the available exceptions.

Thanks again,
Brian