By Sarah Brenner, JD
Director of Retirement Education
Hurricane season is upon us. Wildfires are raging in the West, and many states are dealing with flooding from summer storms. Natural disasters are increasingly common. After the impact comes the cleanup…and the cost. While tapping a retirement account early is never ideal, for some victims of natural disasters there may be no other option to pay the resulting bills. Fortunately, the rules do offer some relief for these account owners.
Penalty-Free Distributions
A qualified disaster distribution from a retirement account is exempt from the 10% early distribution penalty. This includes a distribution made to an individual whose principal place of abode is in a federally declared disaster area and who has sustained an economic loss caused by the disaster. An individual who has not sustained an economic loss will not qualify for tax relief. The distribution must be taken within 180 days of the first day of the disaster (or, if later, the date the disaster is declared).
The maximum amount that an individual can take from all their retirement accounts combined as a qualified disaster distribution is $22,000. This is a per-disaster limit. A married couple could each take $22,000 from their own retirement plans. There are no restrictions on how the distributed funds are used, and the law does not specifically limit the amount of the distribution to the amount of the damage caused by the disaster.
Repayments
Victims who take qualified disaster distributions also have the opportunity to repay a qualified disaster distribution within three years to a retirement account tax-free. The three-year period will begin on the day after the date the funds were received. Individuals can make one or more recontributions during the three years. Repayments cannot exceed the amount that was distributed. The repayments can be made to any retirement plan to which the original distribution could have been rolled over. They do not have to be made to the account from which the qualified disaster distribution came.
The repayments are considered a direct rollover between a plan and an IRA and a trustee-to-trustee transfer between IRAs. This treatment means that no taxable event is considered to have occurred when a repayment of a qualified disaster distribution is made. It also means the once-per-year rollover rule will not apply to repayments of qualified disaster distributions. If an individual has already paid income tax on their qualified disaster distribution and then later recontributes the funds to a retirement plan, they will be able to file an amended tax return to recover the taxes already paid.
Spreading the Income Tax Over 3 Years
For many individuals struck by a disaster, taking a sizeable taxable distribution from their retirement account could mean more grief, this time from Uncle Sam at tax time. Remember, even though a qualified disaster distribution gets the individual out of the early distribution penalty, they will still have to pay income tax on any pre-tax funds withdrawn. To ease the pain, Congress has included a provision that allows individuals to include the income on their tax return ratably over a three-year period beginning with the year of the distribution. An individual can also elect to include the total amount in income for the year of the distribution.
If you have technical questions you would like to have answered, be sure to submit them to [email protected], to be answered on an upcoming Slott Report Mailbag, published every Thursday.
https://irahelp.com/qualified-disaster-distributions/