IRS Allows Penalty-Free Withdrawal of Stimulus Payments from IRAs

The law of unintended consequences has ensnared some taxpayers who had their “economic stimulus” payments directly deposited into tax-favored retirement accounts, such as IRAs. Many taxpayers choose to have their refunds deposited directly into their bank accounts or into other accounts. What many taxpayers probably did not realize when they made that choice on their returns this year was that their advance refunds under the Economic Stimulus Act of 2008, P.L. 110-185, would also be directly deposited into the account they chose.

For ordinary bank accounts, this should normally present the taxpayer with no difficulty, but direct deposits into tax-favored accounts may cause a problem because such accounts usually have early withdrawal penalties attached to them. Taxpayers might want to spend their economic stimulus payment—that, after all, was the ostensible purpose of the payments in the first place—but will be faced with a penalty and taxes if they withdraw the money.

As a result, the IRS has announced that taxpayers who had their economic stimulus payments deposited directly into a tax-favored account can generally withdraw amounts up to the amount of that payment tax free and penalty free until the due date of their 2008 income tax return, including extensions (Announcement 2008-44).

Eligible accounts include traditional and Roth IRAs, health savings accounts, Archer medical savings accounts, Coverdell education savings accounts, and qualified tuition programs (529 plans).

Regular refunds deposited into such accounts are not eligible for this treatment. Taxpayers who elected to have their refunds directly deposited into more than one account will not be affected; they will receive their economic stimulus payment in the form of a paper check.

For a detailed discussion of the act, see Jones, “The Economic Stimulus Act of 2008,” p. 443.