Compliance News | May 13, 2024

IRS Explains New Disaster Relief Distribution and Loan Rules

The IRS has issued FAQs addressing the disaster relief provisions of the SECURE 2.0 Act of 2022 (SECURE 2.0), which gives retirement plan sponsors the option to provide distribution and loan relief in response to a “qualified disaster,” which is a major disaster declared by the president and indicated on the Federal Emergency Management Agency (FEMA) website.

The relief allows:

  • Special distributions
  • Repayment of distributions taken for principal residence purchase/construction
  • Larger loans and delayed repayment
Senior Couple Checking Ruins After Fire Disaster

The IRS is issuing these FAQs as general guidance to help plans administer the new relief. Plans that reasonably and in good faith rely on these FAQs will not be subject to any penalty that provides a reasonable cause standard for relief (such as a negligence penalty) for underpayment of tax.

However, while reliance on the FAQs provides penalty relief, it does not provide relief from complying with the law if a FAQ turns out to be an inaccurate statement of the law.

Before SECURE 2.0, a plan could provide such relief only if Congress enacted a special law for the specific disaster. We discussed all SECURE 2.0 provisions, including disaster relief, in our January 4, 2023 insight, “SECURE 2.0 Retirement Reform Becomes Law.”

The FAQs clarify that plan sponsors may opt for the relief to be permanently in effect so the disaster declaration triggers the availability, or they may choose to provide the relief on a case-by-case basis. Also, they may limit the relief to, for example, distributions and not loans. Additionally, the plan may provide for smaller distributions or smaller loans than the maximum.

A participant is a “qualified individual” if the individual’s principal residence is in the “qualified disaster” area at any time during the incident period and the participant has sustained an economic loss by reason of the qualified disaster. The “incident period” for a qualified disaster is the period specified by FEMA as the period of a disaster. These periods are listed on the FEMA website. A plan may rely on the participant’s reasonable representations that the distribution satisfies the conditions unless the plan has actual knowledge to the contrary.

Special distributions

Different types of retirement plans have different rules as to when participants may take distributions, and, even if the distribution is permitted, there may be a 10 percent penalty for distributions received before age 59½ (unless a special exception applies). A “qualified disaster recovery distribution” is not subject to those distribution restrictions or the penalty; and such a distribution has special tax and rollover treatment.

SECURE 2.0 creates a special rule treating a disaster distribution as a distributable event in 401(k), money purchase, section 403(b) and governmental 457(b) plans. SECURE 2.0 does not create a special distributable event in the case of a DB plan; the special rules apply to a DB plan only if the participant already may receive a distribution from the plan (for example, because of separation from service). Any distribution from a DB plan or money purchase plan must have spousal consent.

The maximum amount of the distribution is $22,000 from all plans for a specific disaster. Covered distributions are those made on or after the first day of the incident period and before the date that is 180 days after the latest of the first day of the incident period or the date of the disaster declaration.

In general, participants may repay all or part of the distribution within three years. The repayment is treated as a rollover. A plan is not required to allow repayment of the disaster distribution if it does not accept other rollovers. With respect to plans that accept rollovers, the IRS only states that it “expects” such plans will accept rollovers of these distributions. Rollovers to IRAs are an alternative means for the participant to avoid taxation. Taxation of the distribution is over three years proportionately (unless the participant elects to include the entire distribution in income in the year of receipt) and any rollover of distributed amounts could require amended tax returns if the rollover is delayed until the end of the required period.

Repayment of distributions taken for principal residence purchase/construction

A qualified distribution taken for purpose of purchasing or constructing a principal residence in a qualified disaster area may be repaid to the plan to avoid taxation on the distribution. A qualified distribution is one taken by a first-time homebuyer that was used to purchase or construct a principal residence in a qualified disaster area, but which was not used because of a qualified disaster that affected the area. To be qualified, the distribution had to be received during the period beginning 180 days before the first day of the incident period of the qualified disaster and ending 30 days after the last day of the incident period.

The repayment must occur during the period beginning on the first day of the incident period and ending on the date that is 180 days after the later of the first day of the incident period or the date of the disaster declaration. The repayment must be made solely to an eligible retirement plan of which the individual is a beneficiary and to which a rollover contribution of the distribution can be made. If the repayment is made, the recipient will not owe any income tax on the distribution.

Larger loans and delayed repayment

The provision permits a plan to allow an additional period, up to one year, for repayment of certain outstanding loans (that predated the qualified disaster) and increases dollar limits for new loans. The plan may make the additional period available to any loan outstanding on the later of the first day of the incident period or the date of the disaster declaration. The extension generally may be up to one year and payments after the suspension period will be adjusted to reflect the delay and interest accruing during the delay.

In addition, a plan may increase the maximum amount of a loan from the lesser of $50,000 or 50 percent of the vested benefit to the lesser of $100,000 or 100 percent of the vested benefit if the loan is made during the specified period.

Next steps

The first decision for a plan sponsor is whether to provide disaster relief.

Next, it must decide whether it wishes for such relief to be triggered automatically (i.e., without any need for trustee action) or would rather leave it to trustee action each time there is a major disaster for which the trustees believe relief is appropriate.

Plan sponsors that prefer to decide whether to provide relief each time there is a major disaster may still wish to amend the plan at some point so that such action can simply point to the provisions of the relief that are being activated.

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This page is for informational purposes only and does not constitute legal, tax or investment advice. You are encouraged to discuss the issues raised here with your legal, tax and other advisors before determining how the issues apply to your specific situations.