How to Get Tax Breaks, Tap Retirement Accounts After a Natural Disaster

It is an unfortunate truth that millions of Americans find themselves grappling with the aftermath of natural disasters in any given year, and the past few years in particular seem to have delivered more than their fair share of adversity.

From deadly fires in Hawaii to catastrophic flooding in Vermont, 2023 has brought significant hardship to many American communities. While the lives lost are obviously the deeper tragedy, the temendous collective financial burden adds to the challenges of rebuilding and recovery.

According to data from the National Oceanic and Atmospheric Administration, at a national level, the total cost of major natural disasters between 2018 and 2022 topped $595 billion, with a 5-year annual cost average of $119 billion. This latter figure is nearly triple the long-term inflation-adjusted annual average cost for Americans, NOAA notes.

One silver lining to be found in the wake of such tragedies is the willingness of the federal government, via the Internal Revenue Service, to deliver additional financial flexibility to those grappling with their aftereffects, which can range from damaged or destroyed homes to lost working time and weakened local economies.

Among the government’s most important tools is the permission of penalty-free hardship withdrawals from tax-advantaged retirement accounts, including 401(k) plans and IRAs. The IRS will also often extend key filing deadlines related to these accounts and taxpayers’ other reporting and monetary obligations.

While rightly seen as a key lifeline for Americans in disaster areas, this flexibility comes with a number of key nuances and requirements that can easily cause taxpayers to make mistakes, some of which can be costly. As such, it is important for individuals (and their financial professionals) to study up on the IRS’ disaster relief playbook.

Doing so can help ensure Americans can quickly and efficiently access their savings and investments during times of extraordinary need, without running afoul of the nation’s complex and ever-changing tax rules.

See the list below for a rundown of key facts all Americans should know about retirement savings, hardship declarations, disaster relief and income taxes, drawn from IRS resources and the ALM’s Tax Facts library.

Want more tax-focused insights? Find current and accurate answers to your tax questions with Tax Facts.

Presidentially Declared Disasters

As recounted on the IRS website, the Bipartisan Budget Act of 2018 mandated changes to the 401(k) hardship distribution rules, and in November of that year, the IRS released proposed regulations to implement these changes.

The IRS released final regulations about a year later, and generally, these changes relaxed certain restrictions on taking a hardship distribution, including in disaster situations.

Under the framework established in 2019, in the event of a presidentially declared disaster, the IRS will postpone certain retirement plan and IRA deadlines for affected taxpayers. For example, the IRS may extend the 60-day period for plan participants to deposit eligible rollover distributions to another qualified plan or IRA, or it may extend the time for a qualified retirement plan to make a required minimum distribution.

Most presidentially declared disasters are severe storms such as tornadoes and hurricanes, but they may also be wildfires, flooding or earthquakes. Affected taxpayers are generally people who live in or have a business in an area directly affected by the disaster.

Soon after a disaster is declared, the IRS will issue a news release describing the type of relief; which deadlines are being postponed; the taxpayers eligible for relief; and duration of the relief period, among other key information.

Secure 2.0 and Natural Disasters

With passage of the Setting Every Community Up for Retirement Enhancement (Secure) 2.0 Act in 2022, the rules governing access to retirement accounts in the wake of natural disasters were changed again, this time being relaxed to allow penalty-free access to retirement funds in certain common circumstances.

If the disaster qualifies as a federally declared disaster, taxpayers can now generally access up to $22,000 per disaster without application of the 10% early withdrawal penalty.

Further, the tax liability generated by the retirement account withdrawal can be spread over three years, and taxpayers can typically repay the funds within three years of the withdrawal to avoid tax consequences altogether.