The recent wildfires in California have left a devastating impact on families, businesses, and entire communities. A fresh analysis suggests that the initial property damage could reach a staggering $45 billion. While insurance will cover some of those costs, many people are still facing hefty out-of-pocket expenses with seemingly nowhere to turn.
On a more positive note, individuals can access their retirement savings to cover costs associated with federally declared disasters. However, it’s crucial to understand the rules before opting for this route, and even if you qualify, it might not be your optimal choice.
A person overwhelmed by stress sits in their car amidst this turmoil.
Understanding Disaster Relief Withdrawals from Retirement Accounts
The SECURE 2.0 Act, enacted at the end of 2022, offers a provision allowing Americans under the age of 59 1/2 to withdraw from their retirement savings without the usual 10% early withdrawal penalty, but only under specific circumstances.
To be eligible, you’ve got to have suffered an economic loss from a federally declared disaster. You can verify your eligibility by using FEMA’s Disaster Search.
If you qualify, you can withdraw up to $22,000 from your IRA or employer-sponsored retirement plans such as a 401(k) or 403(b). It’s vital to note that the $22,000 cap is the total you can withdraw from all your accounts, not just a single one. These withdrawals must be made within 180 days from the start of the incident period or the date the disaster was declared, taking whichever date is later.
While taxes are due on these withdrawals, the Act allows you to spread the tax payments over three years instead of settling them all at once. You also have the option to pay back these distributions, but it’s not mandatory. If you choose to repay the funds later on, you can amend your tax returns for any years in which you paid taxes on them.
For instance, withdrawing funds in 2025 with taxes spread out, and repaying everything by 2027, means you won’t owe taxes on these withdrawals in 2027. You can also claim refunds for the taxes paid in 2025 and 2026 by filing amended returns.
Another choice on the table is a 401(k) loan, provided your employer allows it. This might let you withdraw more than the standard amount and offer an extra year for repayment. Yet, again, you must have experienced an economic loss from a federally declared disaster to qualify. Employers ultimately decide whether to extend these more favorable loan conditions.
Weighing the Pros and Cons
Being able to access your retirement funds penalty-free can be a significant relief in such trying times. This opportunity is particularly valuable if securing a bank loan becomes problematic. Since these savings are yours, you don’t need to worry about credit checks or filling out loan applications.
However, it’s wise to explore other means of obtaining the funds you need. Tapping into your retirement savings, even temporarily, sacrifices potential growth on those funds. This can complicate your future retirement plans, possibly requiring you to ramp up your savings dramatically or delay retirement altogether.
Therefore, consider all other avenues, like traditional loans, before dipping into your retirement account. If you ultimately decide to proceed, ensure you withdraw only what’s necessary and keep within the $22,000 cap.
