[LisaB4657]

I understand that a person can make a penalty-free withdrawal from a traditional IRA if they are unemployed and have to pay for health insurance.

So let's say that a person became unemployed on Dec. 31, 2007, and has been collecting unemployment benefits since that time. From January 31, 2008 to now they have paid $12,874.54 for health insurance on a monthly basis. Can they now withdraw that amount from their IRA without penalty? Or does the withdrawal need to be within a certain time after the health insurance was paid?

[AtlantaTaxExpert]

Lisa:

Based on your posting, you CAN withdraw $12,875 and NOT pay the 10% Early withdrawal Penalty. The withdrawal must be completed sometime in the 2008 calendar, and you may need to prove to the IRS that you paid this amount for your health insurance.

However, note you WILL pay federal and state income tax on that $12,875. That being the case, the IRA custodian will withhold 20% to send to the IRS when the distribution is made. That is required by law.

[LisaB4657]

Lisa:

Based on your posting, you CAN withdraw $12,875 and NOT pay the 10% Early withdrawal Penalty. The withdrawal must be completed sometime in the 2008 calendar, and you may need to prove to the IRS that you paid this amount for your health insurance.

Great! And providing proof will be no problem.

However, note you WILL pay federal and state income tax on that $12,875. That being the case, the IRA custodian will withhold 20% to send to the IRS when the distribution is made. That is required by law.

I understand that. But will that 20% be considered a prepayment of my 2008 taxes? What I mean is, if I prepare my 2008 taxes next year and, after figuring out all of my deductions, I determine that I owe $2500, will that 20% be credited towards that? The same way as if it had been taxes withheld from a paycheck?

[ScottGem]

Yes, if the custodian withholds the 20%, it will be the same as the withholding on a paycheck. First you figure your total tax liability, then subtract all withheld amounts.

[AtlantaTaxExpert]

Yes, it will be credited, just like the withheld income taxes on a W-2 are credited.

You will receive a Form 1099-R which will show the distribution amount and the amount of taxes withheld. A copy of that Form 1099-R will need to be attached to your federal and state income tax returns.

[LisaB4657]

Great! Thank you!!

[AtlantaTaxExpert]

BTW, you will have to file a Form 5329 with your Form 1040 to claim the exemption.

[LisaB4657]

Thanks for the info! Hopefully TurboTax will do this for me. But I'm saving this thread anyway just to be safe.

[AtlantaTaxExpert]

TurboTax WILL provide Form 5329 with instructions on how to fill it out, but it will NOT prepare the form automatically.

You must make the conscious effort to complete Form 5329.