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What you need to know
- SECURE 2.0 is a federal law that will take effect in 2022 and allows certain taxpayers, for major disaster relief purposes, to withdraw money from retirement accounts without penalty.
- For major catastrophes, people can borrow up to $22,000 and take larger loans from their 401(k).
- Taxpayers can take advantage of larger payouts from some plans that offer relief in the event of a major catastrophe.
If you were affected by major disasters, such as wildfires, in California recently, you might be eligible for early withdrawals of your retirement savings without any penalty.
Under SECURE 2.0, a 2022 federal retirement law, individuals affected by federally declared major disasters may be able to take up to $22,000 from their retirement accounts—like 401(k)s and individual retirement accounts (IRAs)—without incurring a 10% early withdrawal penalty. Taxpayers can also repay their distributions within 3 years under disaster relief rules.
“They’re called a qualified disaster recovery distribution—it’s kind of like a last resort for those who are going through an incredibly difficult time,” Scott Sturgeon is the founder and CFP of Oread Wealth.
The Benefits of Using Your 401 (k) for Disaster Relief
IRS reminds taxpayers, in recent tip on taxes, that disaster relief may be available if you live in a declared federal disaster zone or have suffered economic losses as a result of the disaster. This includes property damage and displacement. The Federal Emergency Management Agency declared California Wildfires as a major catastrophe on January 8.
This new provision also allows people to use their 401(k), as well as some homebuyers, who have tapped into their retirement funds early to buy a house that has been damaged by major disasters.
After a disaster, those who borrow 401(k), can do so up to their full plan vested value (but not more than $100,000). They may also defer certain repayments of workplace retirement plans for up to a year. Most people can only borrow up to $50,000 or 50% of the vested balance in their account.
Those that were unable, but had received a distribution for first-time buyers from their IRA, or a withdrawal early from their 401 (k) in order to build or buy a house can repay this distribution.
Access to Funds may require some bookkeeping
Employers can adopt the provisions for disaster relief, but taxpayers on their own may be able to take advantage of qualified disaster recovery distribution.
“If you have a retirement plan that allows you to do this, they should facilitate [you] somewhat. If they don't, you can still do it on your own, but it’s a matter of tracking all this [information],” Sturgeon, said “I'd suggest hiring or working with a tax professional who can help you navigate the filings that you're going to need to do.”
About 8% of employers surveyed prior to the wildfires by Alight, a retirement record-keeper, said they had already adopted the $22,000 withdrawal amount for disasters, while 22% said they were ‘definitely’ going to or ‘likely’ to add it. Of those who were ‘definitely’ going to or 'likely’ to add the provision, more than half said they planned to do so in 2025. Twenty percent of employers have adopted the increased 401(k), disaster loan amounts.
How to Use Retirement Savings?
Sturgeon recommends that people first consider alternative options to get immediate liquidity. These include excess cash and money in brokerage accounts.
That's because when you take money out of your retirement account and put it back later, you're losing out on the tax-deferred growth for those funds, which could affect your retirement savings goals over the long term.
Also, if you're unable to repay the distribution, you'll owe taxes on it.
"If you’re not paying a 10% penalty that’s great, but you’re likely still paying income tax on it if you don’t pay it back and again, lose out on long-term growth," said Sturgeon.
You can add the money that you withdraw and don’t return to your tax as taxable income.
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