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I'm basically trying to get it to where the hands can be moved up to his mouth like he's eating. That's what it looks like in the second screenshot.
Try making this layer hiarchy in Photoshop or Illustrator:
-Frontal <-- (new Layer)
--Arms_OL <-- (New Layer)
---Right Arm <--(under Arms_OL)
---Left Arm <--(under Arms_OL)
--Head <-- (under Frontal)
--Body <-- (under Frontal)
Re-rig the arms in their new layer and it should work
Image example as to how it works on my puppet.