Income Tax Credit for Retirement Plan Early Withdrawals

Legislation was heard this week to create a refundable tax credit to help taxpayers making early withdrawals from their retirement accounts to pay for long-term care expenses. Specifically, it creates a refundable credit equal to the 10% additional federal tax imposed on withdrawals made from qualified retirement plans before the age 59 ½. The credit would only be available if the withdrawn money is used to pay for qualified long-term care services or long-term care insurance premiums.

In most instances, withdrawals made from qualified retirement plans before age 59 ½ are subject to a federal tax of 10% as an early withdrawal penalty, in addition to the regular federal and Minnesota income taxes that also apply to the withdrawn amounts. Under current law, withdrawals due to total and permanent disability or used to pay for certain medical expenses are not subject to the federal penalty. Withdrawals used to cover long-term care expenses or long-term care insurance premiums are subject to that penalty, but this bill would attempt to mitigate that hit by creating a refundable tax credit equal to the same federal tax paid on early withdrawals for these purposes.

The long-term care expenses that would qualify for the early withdrawal would include necessary diagnostic, preventive, therapeutic, curing, treating, mitigating and rehabilitative services, and maintenance or personal care services, that are required by a chronically ill individual and are provided pursuant to a plan of care prescribed by a licensed health practitioner.

Eligible contracts must cover only qualified long-term care services, cannot reimburse expenses incurred for services, must be guaranteed renewable, cannot provide for a cash surrender, and must direct any dividends or refunds of premiums toward reducing future premiums or increasing future benefits.

There is no cap on the available credit and no income limits applied to eligibility. Qualifying expenses would include those paid for the taxpayer or the taxpayer’s spouse or dependents. This credit would be effective beginning Tax Year 2015.

At least 30 other states also offer tax credits or deductions for long-term care expenses. Many states either match the federal deduction or allow for a 100% deduction of premiums that exceed the federal deduction. Thirteen of these states offer a credit rather than a deduction, with benefits that vary widely depending on income and age.  The legislation was heard in the tax reform division and laid over for possible inclusion in the Omnibus Bill. (S.F. 1107)

Senate DFL Media