When a natural disaster, such as a hurricane, strikes, having ready access to cash can be crucial. Depending on the extent of the damage, you may need money to meet your homeowner’s insurance premiums, pay for damage that’s not covered by your insurance or cover day-to-day expenses for a temporary living situation.
Disaster Help from Your 401(k)
In times of extreme crisis the Internal Revenue Service can step in and offer some tax relief to people affected by a disaster. In the aftermath of Hurricane Harvey, for instance, Uncle Sam is allowing 401(k)s and similar employer-sponsored retirement plans to make loans and hardship distributions to victims and their family members more accessible.
The relaxed rules allow savers to borrow up to $50,000 from their vested account balance; they also lift the six-month ban on making new 401(k) contributions after a loan. Note that there’s a deadline (Jan. 31, 2018) to sign up for the rule relaxation. It’s also important to review the rules about paying back a 401(k) loan.
If you don’t have a 401(k), you may be looking to your individual retirement account as an emergency solution. While you can’t get a loan from your IRA, you may be able to make a withdrawal based on hardship. Before you tap your retirement account, however, it’s important to understand the costs.
Withdrawing from Your IRA When Disaster Strikes
Generally, you must be at least age 59½ to take money out of a Roth or Traditional IRA and not be charged a 10 percent early-withdrawal tax penalty. In the case of a Traditional IRA, you’d also be stuck paying income tax on what you withdraw. With a Roth IRA, withdrawals of your original contributions are always tax free. For withdrawals of earnings to be tax free, your IRA must be open for at least five years and you must be 59½ or older.
The easing of restrictions on loans and hardship withdrawals for 401(k)s and other retirement accounts doesn’t change these IRA rules. If you need money to cover costs relating to the storm, the 10 percent early-withdrawal penalty would be the same, as would the income tax rules for earnings. The IRS does allow some exceptions for getting around the 10 percent early-withdrawal penalty. For example, you could avoid the extra tax if you’re withdrawing earnings from a Roth IRA to buy a first home or pay for qualified education expenses.
Taking money from your IRA—even because of a disaster—has an obvious financial downside. Even if you owed no income tax on an early withdrawal from a Roth IRA, the 10 percent penalty could still add to your tax burden for the year. Besides that, you’re shrinking your savings for retirement.
You could add money back to your account once you’re able to save again, but you wouldn’t be able to replace the value of any lost returns during the time that the money wasn’t in your account. And you’d only be able to save up to the annual contribution limits each year, meaning it could take time to replace a significant sum.
IRA Withdrawal Alternatives
In the middle of a disaster it can be difficult to keep a cool head, but it’s important where your retirement is concerned. Before you move forward with an early Roth IRA withdrawal, consider first how much the early-withdrawal penalty and earnings tax may be—as well as how much you could be losing in compound interest down the line. In the long run those costs combined could make an early withdrawal more expensive than raising money through a personal loan or credit card.
A credit card with a 0 percent introductory rate on purchases, for instance, may be a better bargain if you only need a few thousand dollars to tide you over until you get back on your feet. Just remember that purchases and cash advances are two different things. Taking a cash advance from a credit card could trigger a much higher annual percentage rate.
If you’re in doubt about whether an early withdrawal from an IRA makes sense in an emergency, talking with a tax or financial-planning professional could help ease your mind. An advisor could also help you come up with options that you may not have considered. These could help you keep your retirement as intact as possible, despite the damage caused by the storm.