Hurricane Katrina: IRAs, Sec. 401(k)s and Similar Retirement Plans

Under the Katrina Emergency Tax Relief Act of 2005 (KETRA), individuals living in the Hurricane Katrina disaster area (see Exhibit 3) with economic losses resulting from it, may be able to obtain relief through IRAs and Sec. 401(k) and similar plans.

Withdrawals

According to KETRA Section 101, affected individuals may be able to withdraw up to $100,000 from an IRA, Sec. 401(k), Sec. 403(b), governmental Sec. 457 or similar employer-sponsored retirement plan, without being subject to the Sec. 72(t) 10% penalty on early withdrawals; see JCX-69-05 (9/22/05), p. 3, and Notice 2005-92.

Eligibility requirements: To be eligible to make the withdrawal, the individual must have:

• Been living in the Hurricane Katrina disaster area on Aug. 28, 2005; and

• Suffered an economic loss as a result of that hurricane.

Eligible individuals may withdraw up to $100,000 from their retirement plans, penalty-free, from Aug. 25, 2005 to Dec. 31, 2006. They can then include one-third of the withdrawn amount as income on their tax returns each year for three years, beginning with the withdrawal year.

If the amount withdrawn is replaced within three years of receipt, no income tax would be due on it. If tax was paid over the three-year period and the amount withdrawn was subsequently replaced, there will be no need to file an amended tax return to recoup the tax paid.

Example 1: K withdrew $50,000 from her Sec. 401(k) on Oct. 1, 2005 and redeposited it by Dec. 31, 2005. She does not have to pay income tax on the $50,000.

Example 2: K withdrew $60,000 from her Sec. 401(k) on Oct. 1, 2005 and includes one-third of that amount ($20,000) as income on her 2005 return. She then redeposits $60,000 on Dec. 31, 2006. K does not have to include two-thirds of that amount ($40,000) on her 2006 and 2007 returns, and may file for a refund of the tax paid in 2005 on the $20,000.

Example 3: K withdrew $60,000 from her Sec. 401(k) on Oct. 1, 2005 and includes $20,000 as income on her 2005 return, and $20,000 on her 2006 return. On June 1, 2007, she repays $25,000 to her retirement plan. K does not have to include the remaining $20,000 on her 2007 return and may file for a refund of a portion of the tax paid in 2005.

Withdrawal limits: The $100,000 limit on penalty-free withdrawals means individuals cannot withdraw more than a combined total of $100,000 from all of their retirement plans. If they have a Sec. 401(k) and an IRA, for example, they may not withdraw $100,000 from each of them penalty-free. Rather, they may withdraw a combined total of $100,000 between the two of them, such as $60,000 from a Sec. 401(k) and $40,000 from an IRA. If the combined total of all the withdrawals from different retirement plans exceeds $100,000, they will have to pay a Sec. 72(t) 10% penalty on the excess, unless they are eligible for another exception from the penalty.

Caveat: Although individuals may be eligible to withdraw money from their retirement plans as a result of Hurricane Katrina, their plans may not permit early withdrawals. Taxpayers should check with their employers to determine whether their retirement plan permits or is considering permitting this option.

Withdrawals by family members: If individuals have a spouse, parents, grandparents, children or grandchildren living in another part of the U.S., they may be able to borrow or take a hardship withdrawal from their retirement plans to help. They should check with their employers to see whether their retirement plans offer that option.

Eligible family members who decide to withdraw money from their retirement plans may do so through March 31, 2006.

Loans

Under KETRA Section 103, individuals affected by Hurricane Katrina, as noted above, may be able to borrow up to $100,000 (or their entire balance, if less) from their Secs. 401(k) and 403(b), or similar, employer-sponsored retirement plans (this is twice the $50,000 regular limit); for more details, see JCX-69-05 (9/22/05), p. 7, and Notice 2005-92. IRA loans are not permitted.

Eligibility requirements: To be eligible for the loan, the individual must have:

• Been living in the Hurricane Katrina disaster area on Aug. 28, 2005; and

• Suffered an economic loss as a result of that hurricane.

Qualified individuals may borrow up to $100,000 from their retirement plans tax free from Sept. 23, 2005 to Dec. 31, 2006, in addition to any Katrina-related withdrawals made from retirement plans. Thus, it is possible to take $100,000 in Katrina-related withdrawals from a retirement plan (assuming all the requirements discussed under Withdrawals, above, are met) and take another $100,000 in Katrina-related loans from a retirement plan (assuming all requirements are met).

Caveat: While the limit on tax-free loans from a retirement plan may be $100,000, the maximum amount that an individual may be able to borrow could be less. The rules for determining how much can be borrowed are complicated and use a formula that takes into account other loans taken, accrued benefit under the plan and other factors.

Loan limits: The $100,000 limit on tax-free loans is the total of combined loans from all of an employers retirement plans. Individuals with Sec. 401(k) plans and profit-sharing plan accounts, for example, may not borrow $100,000 from each of them tax free. Rather, they may borrow a combined total of $100,000 between them, such as $60,000 from a Sec. 401(k) plan and $40,000 from a profit-sharing plan. If the combined total of all loans from different retirement plans is more than $100,000, Federal income tax may be payable on the excess.

Caveat: Although individuals may be eligible to borrow money from their retirement plans as a result of Hurricane Katrina, their plans might not permit loans. They should check with their employers to see whether their plan permits, or is considering permitting, this option. Also, importantly, loans may have to be paid back with interest.

Pre-Katrina Withdrawals for Home Purchases

Under KETRA Section 102, individuals who withdrew money from their retirement plans to build or purchase a home in what is now the Hurricane Katrina disaster area may be able to redeposit those funds and not pay tax. To be eligible, the individual must have:

• Received money from his or her retirement plan from Feb. 29, 2005 to Aug. 28, 2005;

• Planned to use the money to build or purchase a home in the Hurricane Katrina disaster area; and

• Decided not to build or purchase the home as a result of Hurricane Katrina.

Eligible individuals whose retirement plans permit rollovers may put some or all of the money they previously withdrew back into their retirement plan beginning Aug. 25, 2005 and ending Feb. 28, 2006. They do not have to pay Federal income tax or the 10% penalty for early withdrawals on any amounts repaid to their retirement plan during that period.

Caveat: Individuals who decide not to put any of the money back because they now need to live on it as a result of Hurricane Katrina, will pay Federal income tax and possibly a 10% penalty when they file their 2005 income tax returns. If they put the money back and then withdraw up to $100,000 of it from Aug. 23, 2005 to Dec. 31, 2006, they will not have to pay the 10% penalty and may include one-third of the withdrawn amount on their returns over three years, beginning in the withdrawal year. If they repay the withdrawn amount within three years, they will not have to pay Federal income tax on it (for additional information, see Withdrawals above, and JCX-69-05 (9/22/05), p. 5).

Pre-Katrina Loans

Under KETRA Section 103, if individuals borrowed money from their retirement plans prior to Hurricane Katrina, their loan repayment deadline may be extended a year. To be eligible for the extended deadline, the taxpayer must have:

• Been living in the Hurricane Katrina disaster area on Aug. 28, 2005;

• Suffered an economic loss as a result of that hurricane; and

• A loan repayment deadline from Aug. 25, 2005 to Dec. 31, 2006.

For eligible individuals, the new repayment deadline for a pre-Katrina loan is one year from the original deadline.

Example 4: K borrowed $25,000 from her Sec. 401(k) in 2001; the original deadline of a repayment toward the loan is Oct. 31, 2006. She now has until Oct. 31, 2007 to make that repayment.

From Ruth Wimer, Washington, DC