IRS gives guidance on SECURE 2.0’s terminal illness distributions 

IRS Notice 2024-2 provides guidance on “terminally ill individual distributions” (TIIDs), which are eligible for a new exception under Internal Revenue Code (IRC) Section 72(t) to the 10% penalty tax on retirement plan withdrawals before age 59-1/2. Added to the IRC by the SECURE 2.0 Act of 2022 (Div. T of Pub. L. No. 117-38), the exception applies to distributions made on or after Dec. 29, 2022, to participants with a physician-certified terminal illness reasonably expected to result in death within seven years. IRS plans to issue regulations under Section 72(t) that will include additional guidance on this and other exceptions to the early withdrawal penalty added to the IRC in recent years.

Eligible plans and participants. The notice confirms that TIIDs are available to participants in IRC Section 401(a) defined benefit and defined contribution plans (including 401(k) plans), 403(a) annuity plans, 403(b) plans, and both traditional and Roth IRAs. The notice also indicates that all participants and beneficiaries in these plans may be eligible to receive TIIDs, not just current employees. However, government-sponsored eligible deferred compensation plans under IRC Section 457(b) can’t make TIIDs.

Certification required. SECURE 2.0 requires participants to obtain a physician’s certification of their terminal illness before receiving a TIID. The notice clarifies that a medical doctor (MD) or a doctor of osteopathy (DO) who’s not the participant must make the certification, which has to include the following information:

• Statement that the participant’s illness or physical condition is reasonably expected to result in death within 84 months of the certification
• Narrative description of the evidence used to support the statement (copies of the evidence and other documentation don’t need to be provided)
• Examining physician’s name and contact information
• Date the physician examined the participant or reviewed evidence the participant provided
• Physician’s signature with date and an attestation that the physician composed the narrative description based on a physical examination of the participant or a review of evidence the participant provided

The participant must provide a copy of the physician certification — but not any underlying documentation of the medical condition — to the plan administrator. Plans can’t rely on self-certification, though Congress is currently considering a draft SECURE 2.0 technical corrections bill that would allow participants to self-certify.

Not a 401(k)/403(b) distributable event (yet). The notice also confirms that SECURE 2.0 doesn’t provide an exception for TIIDs to the distributable event rules for 401(k) and 403(b) plans. This means participants in these plans must be otherwise eligible for a plan distribution before age 59-1/2 for TIIDS to receive special tax treatment. This appears to have been a drafting oversight in SECURE 2.0, which adds other exceptions to the early withdrawal penalty (e.g., for personal emergencies and for victims of domestic abuse) and clearly says those exceptions satisfy the distributable event rules. The draft SECURE 2.0 technical corrections bill mentioned above would add similar distributable event language for TIIDs.

Plans can — but aren’t required to — offer special tax treatment. The notice confirms that plans aren’t required to offer TIIDs. Sponsors that choose to do so will need to collect the physician certifications and report the distributions to IRS differently than other withdrawals.

Although participants can’t (yet) take a TIID without being otherwise eligible for a distribution, they would still benefit from the preferable TIID tax treatment for any distribution that would otherwise trigger the early withdrawal penalty. For example, a hardship distribution taken before the participant reaches age 59-1/2 is subject to the early withdrawal penalty unless an exception applies. But if a plan offers TIID treatment (and the employee is eligible for it), the employer would report the distribution on IRS Form 1099-R, Distributions from Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., indicating that the distribution isn’t subject to the penalty.

If a plan doesn’t offer TIIDs, a terminally ill participant who takes an early distribution can still claim TIID treatment on their tax return by filing Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. Thus, the primary benefit of offering TIIDs is to relieve the participant from having to file Form 5329. However, if Congress passes the SECURE 2.0 technical corrections bill that would make TIIDs a distributable event, then 401(k) and 403(b) plans could also provide terminally ill participants with a new distribution option.

No limit on amount of distribution. The notice confirms that there’s no limit on the amount of a distribution that can be treated as a TIID for an eligible participant.

Recontribution allowed. SECURE 2.0 provides that participants can repay TIIDs under rules similar to those that apply to qualified birth or adoption distributions (QBOADs), which are also exempt from the early withdrawal penalty tax. The notice clarifies that a participant can recontribute all or part of a TIID “to a qualified plan in which the employee is a beneficiary” and that can receive rollover contributions. Like QBOADs, participants can repay all or a portion of their TIID during the three-year period that begins on the date of the distribution.

The notice is silent on whether a plan that offers TIID treatment must accept repayment of TIIDs made from the plan. However, IRS guidance on QBOADs says that plans that offer QBOADs must accept repayment if the participant is eligible to make a rollover contribution. The same presumably would apply to TIIDs. Employers that offer TIID treatment on plan distributions but don’t want to accept repayment might want to consult with legal counsel.

Plan amendments. The notice confirms that an employer deciding to offer TIIDs must amend its plan document. For employers that make this change during the SECURE 2.0 remedial amendment period, the plan amendment deadline is Dec. 31, 2026. After the remedial amendment period, the usual discretionary amendment timing rules will apply. So an employer will need to adopt a conforming amendment by the end of the plan year in which the change becomes operationally effective.

• Notice 2024-2 (IRS, Dec. 20, 2023)
• Div. T of Pub. L. No. 117-328, the SECURE 2.0 Act of 2022 (Congress, Dec. 29, 2022)

• Lawmakers release SECURE 2.0 corrections bill for beta testing (Jan. 12, 2024)
• Taking a closer look at SECURE 2.0’s penalty-free distribution provisions (March 13, 2023)
• User’s guide to SECURE 2.0 (regularly updated)