Administration of Terminal Illness Provision of SECURE 2.0

Hi all. Section 326 of SECURE 2.0 regarding terminal illness was effective December 29, 2022, and exempts benefit recipients from the 10% early distribution penalty if they have a terminal illness as defined in Act. They also can repay the distribution under the same terms that apply to the qualified birth or adoption distributions. The Plan Administrator is required to get a doctor's certification providing that the participant meets the statutory definition. IRS has not released any guidance on this. Are your plans administering this? Have your plans been amended for this? Do you intend to amend your plans for this? Any thoughts/experience on this would be welcome. Thanks!

In writing January’s plan amendments, I wrote a definition for a terminal-illness distribution (referring to the subparagraph of the Internal Revenue Code), and added that defined term to the plan’s provision accepting repayments.

There is a logic gap in the statute:

None of §  401(k)(2)(B)(i), §  403(b)(7)(A)(i), §  403(b)(11), and §  457(d)(1)(A) sets up a terminal illness as a reason for allowing a distribution.

A plan might pay a distribution—which the distributee might want to treat as fitting § 72(t)(2)(L)—without the plan’s administrator deciding anything about whether the distributee has, or even has documented, a terminal illness. Rather, a distribution might be provided because the distributee reached age 59½ or has a severance from employment.

It’s awkward to ask a plan’s administrator to receive evidence when the administrator has no current need to consider the evidence administering the plan’s provisions.

But a distributee who wants to preserve §  72(t)(2)(L)’s excuse from a too-early tax or a right to repay an amount into an eligible retirement plan must “furnish[] sufficient evidence to the plan administrator[.]” http://uscode.house.gov/view.xhtml?req=(title:26%20section:72%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section72)&f=treesort&edition=prelim&num=0&jumpTo=true

A distributee might argue that having furnished the evidence is enough, even if the distributing plan’s administrator never considered the evidence. An administrator might keep in its records the evidence received.

I have not yet considered what evidence an administrator should require before a plan accepts a contribution a participant claims is a repayment of an amount from a terminal-illness distribution.

Peter, this is exactly what we are struggling with. The terminal illness provision is not a basis for a distribution on its own. So if the participant is a terminated vested who is 47 years old, wants to cash their benefit out, and meets the terminal illness definition, if we want to help that participant preserve their ability to repay and to get the exemption from the 10% penalty, it seems to me that we, as the payer of a distribution, should offer to take a doctor's certification that the participant meets the Act's definition, and report the distribution on box 7 of IRS Form 1099R as Code 2 - early distribution, exception applies. Now, how he repays it is another question. Do we have to let him repay it to our plan? As you note, if he wants to repay it to his IRA, what is an IRA provider going to require as proof that it was distributed under this Section? Something from us? His 1099R?

We were going to do essentially what you did - add a provision that includes the terminal illness definition and repayment. Thanks, Peter. You're one of the great contributors to this site, BTW.

“Do we have to let [a distributee] repay [a terminal-illness distribution] to our plan?”

I didn’t need to consider that question because the plans I wrote for prefer to allow rollover contributions, transfer contributions, and repayment contribution to the full extent Federal tax law permits.

This topic was discussed at the ASPPA National conference earlier this week.  The bullet points for the discussion were:

• For this purpose, a terminally ill individual means an individual who has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death in 84 months or less after the date of the certification.
• The employee must furnish sufficient proof to the plan administrator that the employee qualifies under this standard.
• Not subject to the 10% early withdrawal penalty tax
• Can be repaid within three years
• Note:  This provision does not create a new distribution right under retirement plans, so a participant would need to be eligible for a distribution under an existing rule.

It was taken as a given that the employee needs a physician to certify the individual is terminally ill and is expected to die within 84 months.

There was a lot of discussion around the employee furnishing proof to the plan administrator.  Some comments addressed HIPAA and privacy concerns.  Other comments were concerned that an employee would be hesitant to disclose to their HR department that the employee was likely to die within 84 months.  The concern primarily focused on the information leaking out and on the impact the information could have on career advancement and salary increases.  These would be a significant burden on an employee where the only additional benefit derived from this disclosure is avoidance of the 10% penalty.

Note that the text of S2.0 326 says "an employee shall not be considered to be a terminally ill individual unless such employee furnishes sufficient evidence to the plan administrator in such form and manner as the Secretary may require".  No one yet knows what the Secretary may require, and there are efforts to have any such requirements acknowledge the privacy concerns. 

The rules for repayment within 3 years for the terminally ill provision points to the QBAD rules in 72(t)(2)(H)(v).  The repayments are at the discretion of the participant and the repayments could be made to an eligible retirement plan or an IRA as a rollover contribution.  The provision does not say the repayments have to be made to the retirement plan from which they are taken.

The question was asked why would a participant want to repay the distribution?  The response was the repayment would be part of a death benefit distributed to the plan's beneficiaries (as opposed to being part of the participant's estate).

The treatment of the terminally ill distribution is different from virtually every other one of the newly or recently added forms of distribution that allow for self-certification.

Expect more clarification to come from the agencies.

Paul I, thank you for widening our information with your top-notch explanation.

To a growing list of interpretation and practical questions, I’ll add another:

Imagine a governmental §  457(b) plan’s participant takes a distribution. Imagine she then has no need for a §  72(t)(2)(L) excuse from a §  72(t) too-early tax because that tax does not apply to §  457(b) amounts. Years later, but within §  72(t)(2)(L)(iv)’s repayment period, the individual wants to repay the amount into an eligible retirement plan, and that plan will accept the payment if accepting the amount as a § 72(t)(2)(L)(iv) repayment is allowed within the plan’s intended tax treatment.

May a repayment-receiving plan rely on a physician’s certification that was dated and signed before the individual took the distribution to be treated as having been a terminal-illness distribution but which never was considered by, nor even furnished to, the distribution-paying plan’s administrator?

Peter, a strict reading of the provision would say the original distribution did not qualify as a distribution on account of a terminal illness because the participant did not furnish the physician's certification to the disbursing plan's plan administrator.  What is a known unknown is the "form and manner as the Secretary may require".

Your scenario is interesting because the participant only needs the distribution to be considered as attributable to a terminal illness so the individual can repay the amount.

The Secretary could be permissive and allow for a repayment if the participant provides the documentation to the plan administrator receiving the payment.  This will not help the 401(k) participant who paid the 10% penalty.

I note that the 10% penalty is not withheld at the time of distribution but is calculated when the participant files a personal tax return.  The Secretary could be permissive and allow the participant to self-report the terminally ill status on the participant's individual tax return at which time the 10% penalty would be treated as not applicable.

Like so much else, we wait for guidance.

This discussion is very informative. I have been considering taking advantage of this provision of SECURE 2.0. My wife has terminal brain cancer. She qualifies for social security disability insurance under the same language of prognosis defined in SECURE 2.0. But, my reading of the law does leave some unanswered questions. 

If she were to withdraw her 401(k) and submit the prognostic paperwork from her physician to the plan administrator, would we be required to repay the funds within three years to qualify for the 10% tax exemption? Or, is it only an option to refund the 401(k) within three years? 

When I spoke with her plan administrator a few months ago, they had little information on how they would verify the illness and prognosis. Their advice was to withdraw and submit the paperwork with our taxes. I'm not sure how that makes sense. I can't imagine that the IRS is verifying diagnoses.

The language in this portion of the bill is so brief that it feels incomplete. Some resources interpreting the bill have stated that persons with a terminal illness can only withdraw when they are terminated from their job, or can only withdraw after 1/1/2024, or that it must be repaid within 3 years. 

I'm a physician and I have not had to deal with this for any patients. But, I'm hoping there is a clearer resource out there. 

Paul I, thank you for your reading—one the Internal Revenue Service might adopt.

(And until the Treasury department or its Internal Revenue Service publishes an interpretation, I’ll ask recordkeepers to provide services to support an individual’s most cautious interpretation.)

Even if one uses only traditional modes and canons for construing and interpreting a statute, there are several possible, and even plausible, constructions and interpretations. Among them:

If a distributee wants the exception from the too-early tax, a cautious reading of the statute is that the physician’s certificate and any further “sufficient evidence” must have not only been made but also have been furnished to the distributing plan’s administrator—even if useless for every claim and every report that administrator would decide—before that plan paid or delivered the distribution the distributee seeks to treat as a §  72(t)(2)(L) terminal-illness distribution.

Yet, § 72(t)(2)(L)(iii) about furnishing “sufficient evidence” [sufficient for which purpose?] to “the [sic] plan administrator” does not express which plan’s administrator must be furnished the evidence. If the only thing anyone might use the evidence for is to persuade a repayment-accepting plan’s administrator that a physician certified the repayment-seeking individual as having a terminal illness and that the physician made that certificate before the individual claimed the distribution from the distributing plan, a court might reason that the administrator a participant could furnish evidence to is the administrator of the plan into which the individual seeks to contribute the repayment.

A practitioner advising a repayment-accepting plan’s administrator might render written advice that such an interpretation is supported by “substantial authority” (a lower standard than more-likely-than-not), which a Treasury rule states can be met with nothing more than a reasoned interpretation of the statute’s text alone. 26 C.F.R. §  1.6662-4(d)(3)(ii) (“There may be substantial authority for the tax treatment of an item despite the absence of certain types of authority. Thus, a taxpayer may have substantial authority for a position that is supported only by a well-reasoned construction of the applicable statutory provision.”), https://www.ecfr.gov/current/title-26/part-1/section-1.6662-4#p-1.6662-4(d)(3)(ii) . And the IRS won’t expect written advice to have considered an authority that had not been published.

About “in such form and manner as the Secretary may require”, one might reason that there is no such requirement or condition (beyond the statute’s other text) until the Treasury department has issued a final, interim, temporary, or proposed rule or the Internal Revenue Service has published subrule guidance of general applicability.

For these and other reasons, the IRS ought not to tax-disqualify a plan for having followed its administrator’s good-faith interpretation that met the IRS’s reasonable-cause standard.

I’m mindful that many recordkeepers, third-party administrators, and other service providers often think in terms of “waiting for guidance”, and might do so for good legal and practical reasons. Yet, when I advise a plan sponsor or a plan’s administrator, I like to be at least preliminarily prepared for what I anticipate my client might ask if it must decide something before an executive agency’s guidance has been published or released.

Osteopathic, I’m so sorry for you and your wife.

While whoever spoke for your wife’s 401(k) plan’s administrator presumably was well intentioned, don’t assume that person knows how best to serve your wife’s or your interests.

If you want my advice, I’d be glad to help you without fee.

You might find advantages in discussing your situation confidentially with not only professional-conduct protections but also the evidence-law privilege for lawyer-client communications.

On 10/27/2023 at 3:48 PM, Patty said:

it seems to me that we, as the payer of a distribution, should offer to take a doctor's certification that the participant meets the Act's definition, and report the distribution on box 7 of IRS Form 1099R as Code 2 - early distribution, exception applies.

Right. That's the only reason to do the certification. And it's very significant. Sure this is complicated and has some delicate (or indelicate) aspects, but think of the alternative? Someone with, say, a $200,000 balance facing a long illness that will likely end in death, and in financial straits (e.g., no LTD) gets their account (which they won't need for retirement) without the $20,000 penalty that would otherwise apply. Seems like a worthwhile provision to me.

If it was set up for the employee to administer (i.e., by checking a box on return) (a) there would be a higher rate of false claims, (b) they would have to wait for a refund from IRS, and (c) there would be a lot more work for IRS.

Regarding repayment within 3 years, in my experience IRA custodians will let the account holder self-certify that the money qualifies, e.g. as a Covid distribution rollover. The taxpayer of course must claim the refund available in connection with the rollover on their 1040.

Without remarking on public-policy questions about the too-early tax and exceptions from it:

If we imagine Congress believed that somehow involving the distributing plan’s administrator might lower false claims that a distributee was terminally ill, such a belief would have been unsound, at least partially.

Even if a plan’s administrator or its recordkeeper receives a physician’s certificate and makes and keeps a document-image record of what was received, the plan’s administrator need do nothing to detect whether a purported certificate is a forgery or other false document, and need not evaluate or even read the certificate.

Yet, that the statute calls for someone who wants the §  72(t)(2)(L) terminal-illness tax treatment to furnish a physician’s certificate might deter some false claims because:

A plan’s claimant might imagine, often mistakenly, that the plan’s administrator will at least look at the certificate.

A plan’s administrator might assume, often mistakenly, that the administrator must or should consider the certificate.

If either of those had been Congress’s reasoning, that would be a deplorable way to make law.

Whatever the awkwardness of receiving evidence the administrator has no current need to consider, I suggest a plan’s administrator ask its recordkeeper to make and keep records of whatever the recordkeeper received for a §  72(t)(2)(L) certificate. I suggest that even when the certificate is irrelevant to deciding a claim. And I suggest it even when the certificate is irrelevant to coding a Form 1099-R—whether because no too-early tax would apply anyhow, or because the payer does not apply to Form 1099-R coding a fact the plan’s administration did not decide.

Whether a payer must, should, or even may code a Form 1099-R for an exception from a too-early tax when the distributing plan’s claims administrator did not decide or determine a fact that would invoke the exception is not a point I remark on in this discussion.

The Internal Revenue Service’s nonrule interpretation includes this:

Q.F-15: If a qualified retirement plan does not permit terminally ill individual distributions, may an employee treat an otherwise permissible in-service distribution as a terminally ill individual distribution?

A.F-15: Yes. If a qualified retirement plan does not permit terminally ill individual distributions and an employee receives an otherwise permissible in-service distribution that meets the requirements of both the permissible in-service distribution and a terminally ill individual distribution [see Q&A F-1], the employee may treat the distribution as a terminally ill individual distribution on the employee’s federal income tax return. As part of the employee’s tax return, the employee will claim on Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, that the distribution is a terminally ill individual distribution, in accordance with form’s instructions. The employee must retain the physician’s certification that meets the requirements of Q&A F-6 and F-13 of this notice in the employee’s tax files (as required by [I.R.C. § ] 6001) in case the IRS later requests the certification. The terminally ill individual distribution, while includible in gross income, is not subject to the 10 percent additional tax under section 72(t)(1). If the employee decides to recontribute the amount to a qualified retirement plan, the employee may recontribute the amount to an IRA.

For example, on May 15, 2024, Participant B, age 50, goes to the doctor and gets a certification of terminal illness that meets the requirements of Q&A F-6 of this notice. Participant B’s plan, a section 401(k) plan, does not permit terminally ill individual distributions but does permit hardship distributions. On June 10, 2024, Participant B applies for a hardship distribution in the amount of $15,000. When Participant B files his tax return, Participant B indicates on Form 5329 that the distribution is excepted from the 10 percent additional tax as a terminally ill individual distribution under section 72(t)(2)(L). Participant B retains the physician’s certification, dated May 15, 2024, with Participant B’s files as part of Participant B’s tax returns for tax year 2024. Participant B does not owe the additional $1,500 (representing the 10 percent additional tax of the amount includible in gross income). Unlike a hardship distribution, Participant B may also recontribute the $15,000 to an IRA following rules similar to qualified birth or adoption distributions.

Miscellaneous Changes Under the SECURE 2.0 Act of 2022 , Notice 2024-2, 2024-2 I.R.B. 316, 327 (Jan. 8, 2024), https://www.irs.gov/pub/irs-irbs/irb24-02.pdf .

I read Q&A F-15, including its example, as allowing a distributee the exception from the too-early extra tax (and a limited recontribution opportunity) even if the claim for the distribution did not furnish the physician’s certification.

BenefitsLink neighbors, do you concur?

If the plan’s claims procedure for a hardship distribution normally does not receive any evidence beyond the participant’s self-certifying statement on the electronic or paper claim form, am I right in thinking a plan’s administrator need not receive a physician’s certification?

If a plan’s administrator need not receive a physician’s certification, might an administrator deliberately not receive it, to avoid privacy and security risks about the individual’s information?

I concur.

The IRS procedure essentially is allowing the participant to self-certify with the condition participant must preserve the documentation in the form of the physician's certification.

The only circumstance where the employer would(should?) ask for documentation is if participant wishes to repay the distribution.  The employer may decide if a copy of the 5329 filing suffices as adequate documentation (which would preserve some level of privacy for the participant), or the employer may ask for a copy of the physician's certification.  Either way, it would be prudent for the participant to keep both the 5329 and the physician's certification if they are contemplating possibly making a repayment.

If a taxpayer obeys the Notice and keeps her records, including the physician’s certification, as Internal Revenue Code §  6001 directs, her recontribution opportunity ends before the records-retention period ends. See 26 C.F.R. §  1.6001-1(e) https://www.ecfr.gov/current/title-26/part-1/section-1.6001-1#p-1.6001-1(e) .