Senate Bill Offers Retirement Plan Tax Breaks to Cope with Midwestern Storms

September 26, 2008

The disaster recovery and tax extenders bill passed by the Senate on September 23, 2008 contains three disaster-related retirement plan changes for participants in disaster areas in 10 Midwestern states that experienced floods and tornadoes earlier this summer.

The Senate action is an amendment to a House measure, the Renewable Energy and Job Creation Act of 2008 (H.R. 6049). The Disaster Tax Relief Act of 2008 (H.R. 7006) passed by the House on September 24, 2008, does not contain any retirement plan provisions. It is likely, however, that Congress will approve the Senate version of the bill and send it to the President for signature.

The Senate bill provides tax relief for victims in Arkansas, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska and Wisconsin. The proposals are applicable to floods, severe storms and tornadoes declared by FEMA between May 20, 2008, and before August 1, 2008.

The three retirement plan provisions are:

Qualified Disaster Recovery Assistance Distributions.
The proposal waives the 10 percent penalty tax if a distribution from an individual retirement account (IRA) or tax favored retirement plan such as a 401(k), 403(b), or 457(b) plan is considered a qualified Disaster Recovery Assistance distribution.

To be considered a qualified distribution it would have to be made on or after the declared disaster date and before January 1, 2010. And it has to be made to an individual whose principal residence is located in the designated disaster area and who sustained an economic loss because of the disaster.

The waiver is limited to $100,000 or less. Participants receiving a qualified distribution would be permitted to spread the income tax resulting from the distribution over three years. The amount distributed may be re-contributed to the plan over a three-year period following the distribution, but would not be included in income.

Re-contribution of Withdrawals for Home Purchases.
The proposal allows distributions for home purchases that were made from 401(k) or 403(b) plans or IRAs under certain condition. Amounts must be re-contributed within five months from the date of enactment of this bill in order to receive the tax break.

Loans from Qualified Plans.
The proposal effectively doubles the limitation on loans from a 401(k), 403(b), or 457(b) plans by allowing participants to receive loans up to the lesser of $100,000 or 100 percent of the vested accrued benefit for loans made after the date of enactment and before January 1, 2010.

In addition, outstanding loan payments due on or after the applicable declaration date and before January 1, 2010 may be deferred an additional 12 months, with appropriate adjustments for interest.