For many whose lives have been turned upside down by a natural disaster, often the majority of their savings is tied up in their retirement account. Without a homeowners insurance policy, or if the damage is minimal enough that making a claim isn’t worth the risk of increased premiums, one may find that what they have been able to amass in their 401(k) is their best alternative to taking a loan and adding to their monthly expenses. The only way to access retirement savings while retaining employment is, as the name implies, through an in-service distribution such as one for hardship.
Unfortunately, unless you are in your mid- to late-50s, any in-service distribution to cash will result in an additional 10% tax penalty (aka, “early withdrawal penalty”) and can really salt the wounds of those experiencing a serious hardship. For the most part, this is still the case: The IRS, for understandable reasons, continues to insist that the tax advantages provided to retirement plan contributions results in increased savings for retirement, not the go-to resource for people needing to tap their savings in general.
That said, it appears that Congress and the IRS are certainly interested in people gaining access to their retirement savings without undue penalty for serious claims, as evidenced by recent changes to hardship withdrawal options in the SECURE 2.0 Act. Among them is Section 331, which makes the following changes:
- Exempts up to $22,000 per disaster from the federal 10% early withdrawal penalty
- Spreads the tax liability for the withdrawal over the course of three years, and
- Gives the participant the opportunity to repay the money to the plan to offset the tax liability
- This relief applies to qualified plans with respect to any federally declared disaster occurring on or after January 26, 2021.
So how can you tell the difference between a significant weather event and a federally declared disaster? Ask FEMA: https://www.fema.gov/disaster/declarations.
Keep in mind that this change has been made only recently as of the date of this blog, so your employer may not have made the decision to incorporate the administrative complication to allow for these types of hardship withdrawal expansion. If you are interested in making a claim and leveraging these new rules, it would be wise to check with your employer to ensure your expectations align with the current structure of your 401(k) plan and express your interest in this new provision. If your employer is not interested in making a change, you are still eligible for the exemption from the early withdrawal penalty and the relief that comes from spreading the income out over three years, but you may find the repayment option is not available to you.