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Disasters can occur at any time, leaving a trail of emotional distress and financial burden. Recovering from a federally declared disaster—like hurricanes, wildfires, and floods—can be daunting, with the immediate need for repairs, replacing belongings, and potential relocation.
Fortunately, the IRS offers some tax relief through Qualified Disaster Distributions (QDDs). This program allows individuals impacted by federally declared disasters to access funds from certain retirement plans without facing the usual 10 percent penalty for early withdrawals. (This is just one example about why retirement planning is so important.)
Let’s talk about Qualified Disaster Distributions, starting with what this program is, who may be eligible, and any tax implications you need to know.
A QDD is a tax provision that waives the 10 percent early withdrawal penalty for distributions taken from retirement plans, such as IRAs, 401(k)s, 403(b)s, and certain government employee retirement plans.
The point of the program is to allow individuals facing financial hardship due to a federally declared disaster—including natural disasters and public health emergencies—to access their retirement savings without incurring the additional tax penalty.
Although QDDs waive the early withdrawal penalty, the withdrawn amount is taxed as income. You can choose to spread the tax burden over three years, potentially lowering your tax liability in any given year, especially if your disaster-impacted income is already lower.
In some retirement plans, QDDs can be treated like a rollover contribution, allowing for repayment within a timeframe (usually three years) to replenish your savings while accessing them during hardship.
Retirement can feel overwhelming and retirement planning can be a lot. Check out some frequently asked questions from retirement planners just like you and come to one of our seminars near you to get information you need around retirement.
To be eligible for a QDD, you must meet the following two criteria:
It’s important to know that the IRS bases loss on the adjusted basis of your property. You may qualify for a QDD even if your insurance covers some of the damage.
Navigating the Qualified Disaster Distribution process requires attention to detail as there are alot of moving parts. And if you’re applying for this program, you’ve been affected by a disaster and life may be moving quite quickly.
You must confirm that your primary residence is located in a federally declared disaster area (check FEMA's website for your status). You must have sustained losses to your primary residence or a business located in the disaster area caused by that federally declared event.
Review your specific retirement plan documents because each plan has its own withdrawal procedures. Some might have stricter requirements than the IRS guidelines. Take the time to familiarize yourself with your plan's details to avoid any unexpected issues once you do contact your plan administrator.
Initiate the withdrawal process by contacting your plan administrator. This is typically your employer's HR department for 401(k)s or the custodian for IRAs.
While completing your withdrawal paperwork, clearly indicate that you are requesting a Qualified Disaster Distribution. You want to avoid the 10 percent early withdrawal penalty.
There are a couple of additional considerations to keep in mind. Some plan administrators might have a waiting period before you can access your funds, even with a QDD. Be prepared to also provide documentation of your residency in the disaster area and proof of losses (like insurance reports and repair estimates) to make the process as smooth as possible.
As mentioned before, the main benefit of a QDD is the exemption from the 10 percent early withdrawal penalty that typically applies to retirement plan withdrawals before the age of 59 and a half. This allows you to access a larger portion of your savings without incurring this additional tax burden.
But a QDD is still considered taxable income, which means you owe taxes on the money you receive. The tax rate applied to you will depend on your overall income tax bracket for the year you receive the distribution.
There is flexibility with a QDD when it comes to reporting it as income on your tax returns. You can choose a relatively simple option of paying the entire amount of QDD tax in the year you receive it, or you can spread it out over three years which can significantly reduce your tax liability in any given year, especially if your income is already lower due to the disaster.
We highly recommend consulting with a tax professional to discuss your specific situation and determine the most tax-efficient way to report your QDD income. They can analyze your financial situation and recommend the best approach based on your current and future income.
Interested in learning more about retirement plans and programs? Consider attending one of our retirement seminars or webinars, hosted by experienced financial advisors who can assist with all your retirement planning needs.
