Tuition Paid from Modified Endowment Contract Distribution

[JohnH]

Client is under 59-1/2 and cashed in a whole life policy.  Insurer said it's a Modified Endowment Contract and issued a 1099-R with Code 1.  Early withdrawal penalty tax applies.  Taxpayer also paid education expenses for their dependent child.  The penalty exception would apply for the amount of education expense paid if this were an IRA, but I'm uncertain whether this exception works with the MEC withdrawal.   Can anyone offer any guidance on this?

[JohnH]

Still researching this, but I'm unable to find anything that definitely says "yes", therefore I'm leaning toward "no" as I have been since the outset.  I had the client pay the full amount of the penalty tax with their extension, explaining that we could claim a refund of the education-related portion of the penalty if we found that it was excludable. But looks like I'm not going to be able to deliver good news on this.  

[Gail in Virginia]

I don't think that you can.  But I cannot provide a site to back this up - I am just basing it on my (limited!) understanding of what an MEC is. 

[Slippery Pencil]

No.  The education exception is for IRAs.  §72(t)(2)(E)

(t)   10-percent additional tax on early distributions from qualified retirement plans

(1)   Imposition of additional tax
If any taxpayer receives any amount from a qualified retirement plan (as defined in section 4974(c)), the taxpayer's tax under this chapter for the taxable year in which such amount is received shall be increased by an amount equal to 10 percent of the portion of such amount which is includible in gross income.

(2)   Subsection not to apply to certain distributions
Except as provided in paragraphs (3) and (4), paragraph (1) shall not apply to any of the following distributions:(A)   In general
Distributions which are -

(i)   made on or after the date on which the employee attains age 59 1/2 ,

(ii)   made to a beneficiary (or to the estate of the employee) on or after the death of the employee,

(iii)   attributable to the employee's being disabled within the meaning of subsection (m)(7),

(iv)   part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his designated beneficiary,

(v)   made to an employee after separation from service after attainment of age 55,

(vi)   dividends paid with respect to stock of a corporation which are described in section 404(k), or

(vii)   made on account of a levy under section 6331 on the qualified retirement plan.

(B)   Medical expenses
Distributions made to the employee (other than distributions described in subparagraph (A), (C), or (D)) to the extent such distributions do not exceed the amount allowable as a deduction under section 213 to the employee for amounts paid during the taxable year for medical care (determined without regard to whether the employee itemizes deductions for such taxable year).

(C)   Payments to alternate payees pursuant to qualified domestic
relations orders
Any distribution to an alternate payee pursuant to a qualified domestic relations order (within the meaning of section 414(p)(1)).

(D)   Distributions to unemployed individuals for health
insurance premiums(i)   In general
Distributions from an individual retirement plan to an individual after separation from employment -

(I)   if such individual has received unemployment compensation for 12 consecutive weeks under any Federal or State unemployment compensation law by reason of such separation,

(II)   if such distributions are made during any taxable year during which such unemployment compensation is paid or the succeeding taxable year, and

(III)   to the extent such distributions do not exceed the amount paid during the taxable year for insurance described in section 213(d)(1)(D) with respect to the individual and the individual's spouse and dependents (as defined in section 152).

(ii)   Distributions after reemployment
Clause (i) shall not apply to any distribution made after the individual has been employed for at least 60 days after the separation from employment to which clause (i) applies.

(iii)   Self-employed individuals
To the extent provided in regulations, a self-employed individual shall be treated as meeting the requirements of clause (i)(I) if, under Federal or State law, the individual would have received unemployment compensation but for the fact the individual was self-employed.

(E)   Distributions from individual retirement plans for higher education expenses
Distributions to an individual from an individual retirement plan to the extent such distributions do not exceed the qualified higher education expenses (as defined in paragraph (7)) of the taxpayer for the taxable year. Distributions shall not be taken into account under the preceding sentence if such distributions are described in subparagraph (A), (C), or (D) or to the extent paragraph (1) does not apply to such distributions by reason of subparagraph (B).

(F)   Distributions from certain plans for first home purchases
Distributions to an individual from an individual retirement plan which are qualified first-time homebuyer distributions (as defined in paragraph (8)). Distributions shall not be taken into account under the preceding sentence if such distributions are described in subparagraph (A), (C), (D), or (E) or to the extent paragraph (1) does not apply to such distributions by reason of subparagraph (B).

[JohnH]

Thanks to both of you for the replies.  Guess I'm just trying to "torture the text" to get a desired outcome..  This helps me to go ahead and wrap this one up.  I appreciate the confirmation.

 

[KATHERINE]

 

Hi dear friends, what exactly below says then?   Thank you!

https://www.irs.gov/pub/irs-drop/rp-01-42.pdf

[JohnH]

Hi Katherine:  Just to be clear on what you are saying.  I assume you are pointing out that the ONLY exceptions to the 10% penalty for a taxpayer who is under 59 would be either 1) disability as defined; or 2) a qualifying SEPP.  Any other use would be subject to the 10% penalty.  Right?