The recent Disaster Tax Relief and Airport and Airway Extension Act of 2017 provides additional relief and flexibility for retirement plan participants impacted by Hurricane Harvey, Hurricane Irma and Hurricane Maria, including relaxed rules for plan distributions, withdrawals and loans. The relaxed rules are available to any tax-qualified retirement plan with a “qualified individual,” who had a principal residence in a disaster area on a specified date for each hurricane. The Internal Revenue Service (IRS) has not yet provided needed guidance on the new law. The new law is in addition to hurricane relief recently announced by the IRS, Pension Benefit Guaranty Corporation and Department of Labor.
A “qualified individual” is a person who had a principal residence on the “qualified beginning date” in a hurricane “disaster area,” and who sustained an economic loss due to that hurricane. The new law only applies to plan participants, unlike earlier hurricane relief announced by the IRS which also applies to family members. For Hurricanes Harvey, Irma and Maria, a “disaster area” means a major disaster area declared by the president of the United States. A list of such areas may be found at www.fema.gov/disasters.
The “qualified beginning date” is different for each hurricane:
- August 23, 2017 for Hurricane Harvey
- September 4, 2017 for Hurricane Irma
- September 16, 2017 for Hurricane Maria
Hurricane Withdrawals and Distributions
The new law waives the 10 percent penalty tax on in‑service withdrawals and distributions that are received by a qualified individual (defined above) from a tax-qualified retirement plan, including a plan covered under section 401(k) or 403(b) of the Internal Revenue Code. Normally, the 10 percent penalty tax applies to a post-service distribution received before age 55 or to an in-service withdrawal received before age 59-1/2. The new legislation removes the 10 percent penalty tax on hurricane distributions or withdrawals, up to $100,000 (reduced by any other qualified hurricane distribution). To avoid the tax penalty, the qualified individual must receive the withdrawal or distribution on or after the qualified beginning date (defined above) and before January 1, 2019. In calculating the maximum amount available for tax penalty relief, all distributions and withdrawals to the qualified individual during this period are aggregated, including withdrawals and distributions from all retirement plans in the employer’s controlled group.
As part of the hurricane relief, income inclusion occurs ratably over a three-year period, beginning with the year the hurricane distribution or withdrawal is received. In other words, a qualified individual may spread out his or her tax payments on qualified hurricane withdrawals or distributions over three years. Qualified hurricane withdrawals and distributions also are subject to different withholding rules, and not subject to the 20 percent mandatory withholding that normally applies.
Hurricane withdrawals and distributions can be repaid by a qualified individual within three years. If repaid, the withdrawal or distribution will be treated as a rollover and will not be subject to income tax. Qualified hurricane distributions and withdrawals, however, are reported for tax purposes in the year the withdrawal or distribution is received. As of yet there is no guidance on how to reverse the income tax on amounts received, but it is likely that a qualified individual will need to file an amended tax return for the year the hurricane withdrawal or distribution was received.
Repayment of Unused Hardship Withdrawal for Disaster Area Residence
If a qualified individual received a hardship distribution between February 28, 2017, and September 21, 2017, for the purpose of purchasing or constructing a principal residence within a hurricane disaster area, but the individual did not purchase or construct that residence on account of a hurricane, he or she may repay the hardship distribution on or before February 28, 2018. If repaid, the hardship distribution will be treated as a rollover as described in the previous paragraph. Like repayment of hurricane withdrawals and distributions, there is no guidance yet on the mechanism for the taxpayer to reverse the earlier tax on his or her hardship withdrawal.
Hurricane Loan Limits and Repayment Holiday
The new law doubles the maximum amount a qualified individual may borrow from a 401(k) plan or other tax-qualified qualified plan. A qualified individual may borrow the lesser of $100,000, or 100 percent of the qualified individual’s vested benefit under the plan (reduced by prior loan balances). Without the new law, the loan limit for tax-qualified retirement plans is the lesser of $50,000 or 50 percent of the participant’s vested benefit under the plan (reduced by prior loan balances). To qualify for the higher loan limits, a tax-qualified retirement plan must make the loan to a qualified individual between September 29, 2017, and December 31, 2018.
For new plan loans to qualified individuals on or after the qualified beginning date, payments due before 2019 may be delayed for one year. In addition, for existing loans to qualified individuals, loan repayments due before 2019 may also be delayed for one year. Interest will continue to accrue during the grace period, and the loan must adhere to all other rules that normally apply to retirement plan loans.
Hurricane Plan Amendments and Next Steps
If the sponsor of a tax-qualified retirement plan wants to provide the relief described above to qualified individuals, plan operations must comply with the new law, and the plan likely will need to be amended by the end of the first plan year beginning after January 1, 2019 (or by December 31, 2019 for a retirement plan with a calendar fiscal year). Given the prior regulatory guidance following Hurricane Katrina, the IRS may issue model amendments or otherwise assist plan sponsors in adopting plan amendments.
If a plan sponsor is interested in applying any of these relaxed rules to its tax-qualified retirement plan, the sponsor should discuss the advantages and requirements of the new law with its regular McDermott attorney or one of the listed authors.