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Retirement plan tax rules when using the savings to recover from a disaster

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Tornadoes storms across the United States this year are striking at a record breaking pace. The National Weather Service’s Storm Prediction Center today shows 790 preliminary tornado reports. The historical average at this point in the year is around 550.

Here in Texas, more than a million acres in the Panhandle were consumed by the Smokehouse Creek Fire that erupted in February. As spring arrived, the eastern part of the Lone Star State endured devastating floods. And hurricane season doesn’t even officially start until June.

All this meteorological anger means that millions of people are, or likely will be, facing cleanup costs. If they have insurance, the policies will help … after they meet the coverage deductible. Those without any insurance are on their own.

Tax relief for disaster victims: In areas that are declared major disaster areas by the president following Federal Emergency Management Agency (FEMA) review, the Internal Revenue Service will provide some tax relief to affected residents.

The second Setting Every Community Up for Retirement Enhancement (SECURE) Act, enacted in late 2022 and known as SECURE 2.0, also provides ways for disaster victims to get help, notably by using their tax-advantaged retirement funds, if they are in federally declared disasters that occur on or after Jan. 26, 2021.

Prior to the changes made by SECURE 2.0, there was no general disaster relief regarding retirement plan distributions and loans. Instead, Congress had to act separately, on a disaster-by-disaster or year-by-year basis, to provide this type of relief to those in major disaster areas.

Now SECURE 2.0 provides ongoing disaster relief for these distributions and loans by those who need the money to help them recover from a declared major disaster.

Here are the highlights.

59½ penalty withdrawal waiver: Many people don’t have enough set aside to cover emergency expenditures. But if they have retirement savings, they often tap that future money to take care of here-and-now disaster needs.

Under SECURE 2.0, the 10% penalty on distributions taken by owners younger than 59½ is waived. This applies to IRAs and workplace retirement plans.

It applies to up to $22,000 per disaster. And the payout must generally be taken within 179 days of the date the disaster is declared.

The retirement plan owner can pay back these qualified disaster distributions. That payback can be done in a lump repayment, or completed over three years.

However, federal tax on the withdrawals still is assessed. Amounts recontributed to the retirement account within the three-year period that begins on the day after the date the qualified disaster distribution was received are treated as taxable rollovers.

Taxes paid over three years must be reported using Form 8915-F when you file your annual 1040 for the year you receive the disaster payout.

You can recover income tax paid on a distribution that is later rolled over within three years of the payout by filing an amended return on Form 1040-X.

Workplace plan disaster loans: If you opt to borrow from rather than withdraw retirement savings in an employer-sponsored plan, you can borrow up to the lesser of $100,000 or 100 percent of the account balance.

Repayment terms also can be extended by up to one year, if your employer opts to provide this disaster relief option.

Some pre-disaster payouts can be recontributed: If you got a loan from your workplace plan to buy a house before the disaster hit, but didn’t ultimately use the money to buy the home, you can put the money back into the account.

This home purchase option is a special 401(k) tax exemption available to first-time homebuyers. You can withdraw up to $10,000 from your workplace plan without incurring the 10 percent penalty to buy your first residence. Taxes, however, are still due on the withdrawal.

Under the SECURE 2.0 provisions, a prospective homebuyer in a disaster area generally has 179 days from the date the disaster is federally declared to repay the funds in a nontaxable rollover. If you already paid the tax, get the money back by amending the return on which you paid the tax.

More IRS information for disaster victims: The IRS has issued Fact Sheet 2024-19, which covers many of the frequently asked questions about the SECURE 2.0 Act’s special rules for retirement plan distributions in the wake of major disasters.

The FAQs are intended to assist individuals, employers, and retirement plan and IRA service providers, and they are divided into the following four categories —

  1. General information
  2. Taxation and reporting of qualified disaster recovery distributions
  3. Repayment of qualified distributions taken for the purpose of purchasing or constructing a principal residence in a qualified disaster area
  4. Loans from certain qualified plans

In addition to this official IRS guidance, you also might find these items on disasters and taxes items of interest:



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