Sandy could blow through IRAs

Hurricane Sandy's pummeling of the Eastern U.S. caused more than $50 billion in damages, according to some estimates. Unfortunately, many of those affected by the storm could be about to exacerbate their situation by making costly financial or tax mistakes. Victims of Hurricane Sandy who need immediate access to funds might be tempted to turn to their individual retirement accounts. In general, distributions from IRAs are taxable, but clients who take a distribution before age 591/2 also will be hit with a 10% penalty unless they meet one of the exceptions allowed under the law. Unfortunately, exceptions do not include financial hardship, no matter how extreme. This often surprises clients. It's not too hard to see why, particularly considering that there are such things as “hardship distributions.”

HARDSHIP RULES

These are distributions of company plan funds that otherwise would be unavailable to a client (IRAs don't have hardship distributions). They are an optional feature and not always available. If your client's plan includes them, check what the hardship rules are and how the distribution might be affected by other factors, such as insurance proceeds the client receives. If a client lives in what the Internal Revenue Service identifies as “covered areas” related to Hurricane Sandy, IRS Announcement 2012-44 grants some relief. It indicates that clients (or their spouses) who live or work in a covered area can qualify for a hardship distribution from their plan based on personal representation. Such distributions must be taken no later than Feb. 1. In addition, a plan that would like to offer hardship distributions may do so before it is amended to include the provision, as long as the plan administrator makes a good-faith effort to make the amendment as soon as possible. Any hardship distribution is subject to the 10% penalty (unless an exception applies). Though there is no general exception for natural disasters, there have been exceptions to the 10% penalty for certain groups of people living in specific areas and affected by specific natural disasters. These exceptions required congressional action and, unlike other forms of relief, could not simply be created by the IRS.

LOAN PROVISIONS

As of this writing, the IRS has exercised its power to adjust some tax deadlines for certain people in affected zones, but Congress has not passed any measure that would provide relief from the 10% penalty for those affected by Hurricane Sandy. If a client's only accumulated cash is in a 401(k) or similar plan and he or she absolutely needs funds, see if the plan has a loan provision. If the answer is yes, it might be possible to access up to $50,000 without paying a tax or penalty. It is usually best to avoid plan loans, but it may be the best among some unfortunate options. In general, the loan must be repaid using level payments over five years or less. If a plan would like to provide loans but doesn't have a loan provision, IRS Announcement 2012-44 lets the plan “offer now, amend later,” as it does for hardship distributions. People also can access funds in a retirement account without paying taxes or a penalty by using what some call a “60-day IRA loan.” A client withdrawing money from an account can repay it within 60 days to prevent the distribution from being taxable and subject to the 10% penalty. Be careful, though. The 60-day clock starts ticking on the day the distribution is received, and clients can do only one 60-day loan per account, per year. Roth IRAs are a possibility, although this is generally the last money you would ever want clients to touch. If they have a Roth, they can take distributions of their contributions with no tax or penalty; converted amounts also can be taken with no taxes due, but the 10% penalty could apply. Earnings may be subject to income tax and/or the 10% penalty, depending on a number of factors. Clients who have been severely affected by Hurricane Sandy probably have more-pressing issues than taxes on their minds. But if they are feeling financial pressure as a result of the storm, they'll appreciate your trying to help them avoid additional taxes or penalties on distributions. Ed Slott (irahelp.com), a certified public accountant, created The IRA Leadership Program and Ed Slott's Elite IRA Advisor Group.