Hurricanes Debby, Helene and Milton have caused widespread damage across Florida and much of the Southeastern United States in recent weeks. As affected taxpayers begin to put their lives back together, many are encountering unprecedented financial costs even before their insurance claims can be submitted and processed.
These taxpayers should be advised about the significant changes made by the Secure 2.0 Act with respect to disaster-related distributions from retirement accounts. Many taxpayers may qualify to take penalty-free distributions and can benefit from expanded retirement plan loan opportunities in the wake of these disasters. However, it's important to evaluate the individual taxpayer's financial situation, options and goals before accessing retirement funds.
Understanding the rules and repayment options can provide valuable assistance to affected taxpayers in the wake of these natural disasters.
Secure 2.0 Act Changes to Disaster Distribution
After a natural disaster, the government often acts to provide relief to victims in the form of expanded penalty-free access to retirement account funds. These provisions are optional, meaning that plans are not required to offer the option. Even if a particular plan does not provide for disaster distributions, individuals may be able to take a hardship distribution, treat it as a disaster distribution on their tax return and avoid early withdrawal penalties.
Under the Secure 2.0 Act, effective for disasters occurring on or after Jan. 26, 2021, participants who live in a federal disaster area may withdraw up to $22,000 as a "qualified disaster recovery distribution" without penalty if the participant suffers an economic loss due to the disaster and the withdrawal is taken within 180 days of the disaster. Qualified disaster areas generally include any area that the president declares to be a major disaster.
An "economic loss" for this purpose may include damage to taxpayers' real or personal property, losses sustained due to being unable to live in their home or loss of income related to being laid off or fired due to the disaster.
The disaster distribution may be repaid within three years without causing the participant to exceed the annual contribution limits. (Repayment is also optional. Internal Revenue Service guidance states that repayments are treated as rollovers, and the plan's otherwise applicable rollover provisions will control).
Although the qualified disaster recovery distributions are treated as taxable income, otherwise-applicable early withdrawal penalties do not apply. However, that tax liability can be spread over the three-year period following the disaster.
