Louisiana flood victims catch a break from the IRS

The IRS is throwing a lifeline of sorts to Louisiana flood victims. It’s allowing affected residents or their family members to take hardship withdrawals or streamlined loans from employer-sponsored retirement plans to help get their lives back in order.

The move relaxes some of the rules on distributions from retirement accounts and expands the list of reasons for a withdrawal for those affected by the disaster to include food and shelter. But financial advisers say those affected by flooding should exhaust all other options before touching their retirement accounts.

One reason: The IRS isn’t giving up its share of the pie. Withdrawals of contributions made on a pretax basis still will incur regular income tax and a 10-percent early withdrawal penalty -- no matter how the money is used. The relaxed rules mirror IRS policy after Superstorm Sandy, but they fall short of the more generous terms, including a waiver of the early withdrawal fee, the agency offered under the Hurricane Katrina Emergency Tax Relief Act.

Current flood victims should hold off on tapping retirement accounts for as long as possible and instead explore disaster loans from the U.S. Small Business Administration, suggested Ralph Leopold, a certified financial planner with Ameriprise Financial in Metairie, Louisiana.

Homeowners, he noted, are eligible to borrow up to $200,000 to replace or repair their primary residence, at rates lower than what their retirement savings is likely to earn. Renters can borrow up to $40,000 to replace personal property.

Borrowing or withdrawing from a retirement account should be “a last resort,” Leopold said. “We have to be very protective of retirement options.”

Atop the “ladder of resources” flood victims should turn to first are liquid savings accounts and “nonqualified” investment accounts (in which you put aftertax money) that aren’t likely to trigger a tax bill, said Bob Mecca, an independent certified financial planner based in Illinois.

Next up would be tax-deferred retirement accounts such as 401(k)s. In that case, a loan is your best option. Those are available to savers with few restrictions, though the IRS says flood victims seeking loans from retirement accounts will be able to get their money quicker, “with a minimum of red tape.”

Loans from retirement plans generally have to be repaid within five years, with quarterly payments. There’s no interest because you’re borrowing from your own savings, but there could be an origination fee. One catch: If you leave your job, you have to repay the loan right away.

“Theory and textbook will tell you not to touch it,” Mecca said of retirement accounts. But the reality is not that easy, he added.

He said the average per-household payout from the Federal Emergency Management Agency is expected to be about $10,000, and that money can be slow in coming.

“There are people that will have to use it,” he said of the hardship-withdrawal option.

His advice: Design a plan to replenish retirement savings as quickly as possible. It’s a strategy the IRS is helping in its own right by waiving, for Louisiana flood victims, the six-month ban on contributions to your retirement plan that normally follows a hardship withdrawal.

Another strategy those who must take a distribution should consider is whether to change the remainder of their retirement portfolio to be more aggressive in hopes of earning higher returns that would more quickly replenish your retirement savings, Mecca said.

Savers in 401(k) and similar plans typically are allowed to take hardship withdrawals for a variety of reasons, including for unreimbursed medical expenses, college tuition, funeral expenses, to prevent foreclosure or to purchase a primary residence. Those withdrawals normally require documentation, but the IRS has relaxed those requirements for flood victims.

Leopold said flood victims should leave retirement savings alone for as long as possible because more help, and potentially better options, could be on the horizon.

“Are we hoping for more?” he asked. “Sure.”