Bridging the Gap for Disaster Victims with New SECURE 2.0 Act Options

by Prof. Robert Bloink and Prof. William H. Byrnes

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 again, 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 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. Understanding the rules and repayment options can provide valuable assistance to impacted taxpayers in the wake of these back-to-back natural disasters.

SECURE Act 2.0 Changes to Disaster Distribution Options

After a natural disaster, the government often acts to provide relief to victims in the impacted areas 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 the particular plan does not provide for disaster distributions, the individual may be able to take a hardship distribution and treat it as a disaster distribution on their tax return and avoid early withdrawal penalties).

Under the SECURE Act 2.0, effective for disasters occurring on or after January 26, 2021, participants who live in a federal disaster area may withdraw up to $22,000 as a “qualified disaster recovery distribution,” or QDRD, 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 the President declares to be a major disaster.

An ”economic loss” for this purpose may include damage to a taxpayer’s 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 and IRS guidance states that repayments are treated as rollovers, and the plan’s otherwise applicable rollover provisions will control). Although the QDRDs are treated as taxable income, otherwise-applicable early withdrawal penalties do not apply to QDRDs. However, that tax liability can be spread over the three-year period following the disaster.

Effective for disasters occurring on or after January 26, 2021, if a participant took a first-time homebuyer distribution within the 180-day period prior to the disaster, the participant may repay the amounts within 180 days after the disaster. This exception to the early withdrawal penalty is only available if the taxpayer was unable to buy or construct the home due to the disaster.

The relevant distribution limits apply across all retirement plans maintained by employers considered to be members of a controlled group.

Plans that can offer QDRDs include 401(k) plans, IRAs, 403(b) plans, governmental 457(b) plans and even money purchase plans. However, the law did not change the distribution rules to allow QDRDs from defined benefit plans.

Expanded Disaster-Related Loan Provisions

The law also amends the rules governing loans taken from retirement plans due to a federal disaster. The limit on such loans is increased to the lesser of $100,000 or 100 percent of the individual’s vested account balance. The generally applicable loan limit (when no disaster has occurred) is the lesser of $50,000 or 50 percent of the individual’s vested account balance. Again, the expanded loan relief is optional for plan sponsors, so it’s important to check plan terms (plans may opt to allow QDRDs and not allow plan loans, and vice versa).

Qualifying participants who are entitled to make use of the expanded plan loan provisions are those who (1) live in a federal disaster area, (2) suffer an economic loss due to the disaster and (3) take the distribution within 180 days of the date the disaster occurs.

Existing loan payments that are due within 180 days of the disaster can be delayed for up to one year (and the generally applicable five-year repayment deadline may also be extended).

Conclusion

In the wake of a disaster, many impacted taxpayers struggle to cover unanticipated costs. Accessing retirement funds without penalty can provide important relief. However, it’s always important to evaluate the individual taxpayer’s financial situation, options and goals before accessing valuable retirement funds—and remember that disaster relief may not be available for all retirement plans.

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