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Hurricane Sandy Financial Recovery: Where You Can Access Funds
By Jeffery Levine, IRA Technical Expert
Follow Me on Twitter: @IRAGuru4EdSlott
Last week, Hurricane Sandy - a.k.a. Frankenstorm - pounded the eastern part of the United States. In the days since, thousands have been displaced from their homes, more are still without power and millions have been financially impacted by the storm that, by some estimates, could top $50 billion in damages. Unfortunately, many of those who’ve been affected could be about to make - or may have already made – a bad situation worse by making costly financial and tax mistakes or top of the losses suffered as a result of Hurricane Sandy.
If you’ve been impacted by Sandy and need access to funds quickly, one place you might be tempted to turn to is your retirement account. If you can avoid doing so, this is probably a good idea, especially if you are under 59 ½. In general, distributions from IRAs are taxable, but if you take a distribution before age 59 ½, you will also be hit with an additional 10% penalty as well, unless you meet one of the exceptions outlined under the law. Unfortunately, financial hardship, no matter how bad that hardship may be, is not one of those exceptions.
There is also no general exception for natural disasters, such as a hurricane. This has, unfortunately, caught some people by surprise over the years, since, at times, there have been specific exceptions to the 10% penalty for specific people, living in specific areas and affected by specific natural disasters.
For example, after Hurricane Katrina, Congress took action and created a limited exception to the 10% penalty for certain distributions taken by some that were affected by that storm. To date, Congress has not enacted any similar provision for those affected by Hurricane Sandy, though to be fair, it’s been less than 10 days since the storm hit – not to mention the last week or so of a highly contentious election season.
So what should you do if you’ve been impacted by Hurricane Sandy and now need to come up with funds quickly? Well, the best places to raise money quickly are typically from some sort of highly liquid, penalty free, low tax-impact types of accounts. For most people, this is your everyday checking, savings or money market account. This is also why one of the first steps any financial professional recommends is an emergency savings fund.
If you don’t have enough cash on hand in one of those types of accounts, the next place you might consider raising funds from is a non-qualified (non-retirement account) brokerage account. Although there might be a tax consequence for selling some of your investments, the investments held in these types of accounts are generally pretty liquid and typically don’t carry penalties when sold. If you are forced to sell some of the investments in these types of accounts, you may want to consider using strategies, such as tax loss harvesting (selling investments at a loss to net against investments sold at a gain) in order to minimize Uncle Sam’s tax bite. On the other hand, selling long-held investments at a gain before year-end might not be such a bad deal anyway, considering that the highest tax rate you’ll pay on long-term capital gains in 2012 is 15% - a rate scheduled to increase to 20% next year.
Don’t have a cash account or brokerage account? Well then it might be time to get a little bit more creative. For instance, you might consider taking money out of an existing home equity line of credit, as the current interest rates are low and you may be able to deduct the interest that you do pay.
If the only money you have accumulated is in a retirement account, and you absolutely need funds, then "you’ve gotta do what you’ve gotta do." However, even here there are a few strategies to consider. One option, if you are a participant in 401(k) or similar plan, is to check and see if your plan has a loan provision. If it does, you might be eligible to access up to $50,000 without paying a tax or penalty. I’m generally not a fan of plan loans because people often make mistakes that cause the loans to become taxable and, perhaps, subject to the 10% penalty, but in this case, it might be the best of some unfortunate options. Of course, like any loans, these must be repaid. In general, the repayment must be made using level payments over a period of 5 years or less.
Another way people sometimes try to access retirement account money without paying a tax or a penalty is by using what some websites, including some from major financial institutions, call a “60-day IRA loan.” Don’t get confused by the name, you can never “take a loan” from your IRA. In fact, if you do, you can kiss your entire retirement account goodbye. Taking a loan from your IRA is what’s known as a “prohibited transaction” and the penalty for making such an error is an immediate distribution of your entire account balance. So if you were to set up a $10,000 “loan” agreement with your $2 million IRA to help pay for a roof repair, you have instantly lost your IRA. All $2 million will be treated as distributed, taxable and perhaps, subject to a 10% penalty. Don’t make this mistake.
So what’s the deal with these so-called IRA loans then? Simply put, these sites are just using some creative language when describing your ability to make a 60-day IRA rollover. If you take money out of one of your IRAs, you can put it back into an IRA within 60 days to prevent the distribution from being taxable, and, if applicable the 10% penalty. Your 60-day clock starts on the day you receive your distribution (i.e. the check arrives at your house). Be careful though, you can only do one 60-day rollover per account, per year. So if you have made a 60-day rollover in the last 365 days, you cannot rollover another distribution from either the account the previous distribution came out of or went into. If you miss the deadline, only IRS can grant you more time through a PLR, but that is an expensive process that can take a lot of time. Plus, in the past, IRS has generally denied 60-day relief rulings where the owner had used the funds within the 60-day period.
One final place to turn to as a possibility? Roth accounts. Although Roth money is generally the last money you’d ever want to touch – after all, why touch money that’s growing tax-free before you have to – desperate times sometimes call for desperate measures. If you have a Roth IRA, you can take distributions of your contributions with no tax or penalty. Converted amounts can also be taken with no taxes due, but the 10% penalty would apply if you are under age 59 ½ and the converted amounts have not been held for five years. If you’re withdrawing earnings from your Roth IRA, they may be subject to the 10% penalty and/or income tax, depending on a number of factors. These rules can be complicated, so you may want to consult with your tax professional first.
So what’s the big take away from all this? The bottom line is this… If you or someone you love has been severely impacted by Hurricane Sandy, chances are you have more pressing issues on your mind than taxes. Making a quick move without thinking though could make a terrible situation that much worse. If you’re already feeling the financial pinch thanks to Sandy, don’t let Uncle Sam tighten the noose with needless and unnecessary taxes and/or penalties.
There’s been enough bad news lately, so let’s at least end on a positive note here. Last week IRS released very limited relief for some tax deadlines, but indicated that more relief would soon be on the way. Plus, now that the election is over and our Congressmen are through campaigning, they should have more than enough time in their lame duck session to get some sort of additional relief, such as an exception to the 10% early distribution penalty passed. If either of these items, or some other type of tax relief come to pass, we’ll be sure to pass that along in a timely fashion.
UPDATE: IRS has just issued further relief for individuals affected by Hurricane Sandy. The relief grants extensions for certain tax deadlines, including 4th quarter estimated tax payments, to February 1, 2013. If you live in certain counties in New York, New Jersey and Connecticut, you are automatically eligible for the relief. If you were affected, but live in other areas, IRS will work with you on an individual basis for relief. For more information on the IRS relief and what areas automatically qualify, click here.
Author’s Note: This article is meant to address immediate and potentially immediate tax issues. It does not address items like casualty loss deductions that may ultimately provide a tax benefit to some, but won’t really come into play until an affected person's 2012 tax returns are filed. We may address those in a separate article here at a later time.