Disaster relief in the tax code
The debris from the August storms seems to be getting cleared, although it was touch-and-go for a while. So many of our neighbors in Northwest Indiana were hit hard, including co-workers and clients whose homes were brutalized by the high winds and tornadoes that ripped through the Region. A storm like that has a way of exposing the soft spots in planning and maintenance. Many of us, including those of us at Oak Partners, realized our emergency-preparedness plans needed tweaking.
As a result of the August 11 storms, straight-line winds, tornadoes and flooding, Northwest Indiana is now under FEMA major disaster declaration DR-4933. President Trump approved the declaration on August 25. Residents and communities in Lake, Porter and LaPorte counties qualify for Individual Assistance and Public Assistance. Households can seek FEMA help for uninsured housing and other needs after filing insurance claims, at DisasterAssistance.gov or 1-800-621-3362.
That presidential major-disaster status also opens a door in the tax code. A qualified disaster recovery distribution of up to $22,000 may be taken from an IRA or 401(k) without the usual 10% early withdrawal penalty if the home was in a designated county during the incident period and the owner suffered an economic loss.
SECURE 2.0 made that relief permanent. Whenever the President declares a major disaster under the Stafford Act, retirement plan owners whose principal home sat in the declared area during FEMA's incident period, and who suffered an economic loss tied to the event -- uninsured property damage, displacement or a layoff -- may take what the law calls a qualified disaster recovery distribution. The cap is $22,000 per disaster, combined across all IRAs and workplace plans. The withdrawal must occur on or after the first day of the incident period and before 180 days after the later of that start date or the official declaration. Miss the window and the special treatment disappears.
The 10% early withdrawal penalty does not apply to that amount, even if you are under 59½. The distribution is still subject to income tax. One useful feature is that the income can be spread over three years, which can help higher earners and, for some retirees, help them stay clear of higher Medicare premiums.
If the need for cash was temporary, all or part of the distribution can be repaid to an IRA or eligible plan within three years. A timely repayment is treated like a rollover and can unwind the tax. Anyone using this rule should be ready to report it on Form 8915-F. Do not assume the 1099-R will be coded the way you hope.
An IRA is usually the simpler path because you control the account. A 401(k) is different. Employers are not required to add disaster distributions as a special in-service event, and many plans have not. If the plan offers it, the account can be accessed while you are still employed. If it does not, a distribution you were otherwise allowed to take can still be reclassified as a qualified disaster distribution on the tax return using Form 8915-F, provided the residence, loss and timing tests are met. An ordinary hardship withdrawal does not get the same income-spreading and repayment treatment and may still be penalized.
Roth IRAs can be used under the same disaster rules. Contributions generally come out tax-free. Earnings can still be taxable if the account is not otherwise qualified for a tax-free withdrawal.
Some planning should come first. Every dollar that leaves a tax-deferred account is a dollar that will not work for the next decade, and the three-year repayment window can close faster than people expect once contractors, deductibles and living costs pile up.
Before requesting a withdrawal, write down the FEMA declaration number, the incident dates and the county, and confirm the address was the primary residence during the disaster. Estimate the real out-of-pocket gap after insurance. Then decide whether $22,000 from an IRA, spread over three tax years, is the least-bad way to close that gap. If it is, take only what you need, calendar the repayment date the same afternoon, and treat the rest of the account as off-limits. Disaster relief in the tax code is a safety valve. It is not a substitute for a plan.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Stock investing includes risks, including fluctuating prices and loss of principal. No investment strategy can guarantee a profit or preserve against loss. Past performance is not a guarantee of future results. This material may contain forward looking statements; there are no guarantees that these outcomes will come to pass.
Marc Ruiz is a wealth advisor and partner with Oak Partners and registered representative of LPL Financial. Contact Marc at marc.ruiz@oakpartners.com .
Securities offered through LPL Financial, member FINRA/SIPC.
