The California wildfires have devastated families, businesses, and entire communities. A recent analysis suggests that initial property losses from the fires could be as much as $45 billion. Insurance will cover some of those losses, but many will face high out-of-pocket costs with no obvious place to turn.

Fortunately, you can tap your retirement savings to pay for damages related to federally declared disasters, but there are key rules to understand before you do this. And even if you’re eligible, it might not be your best option.

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The rules regarding disaster relief retirement account distributions

The SECURE 2.0 Act, passed at the end of 2022, included provisions that enable Americans under 59 1/2 to tap into their retirement savings in certain situations without the typical 10% early withdrawal penalty.

First, this only applies to those who have sustained an economic loss due to a federally declared disaster. You can use FEMA’s Disaster Search to check if you qualify.

If this applies to you, you may withdraw up to $22,000 from your IRA or employer-sponsored retirement plan like a 401(k) or 403(b). The $22,000 limit is the maximum withdrawal amount from all of your retirement accounts, not from each one individually. They must be made within 180 days of the first date of the incident period or the date of the disaster declaration, whichever is later.

Though you’ll still owe taxes on these distributions, you’re allowed to spread them out over three years rather than pay them all in the year you withdraw the funds. You can also pay back these distributions, but you’re not required to. If you do pay the money back in later years, you can file amended returns for the years you paid taxes on these distributions.

For example, if you take a 2025 withdrawal and spread the taxes out before paying it all back in 2027, you won’t owe any taxes on these distributions in 2027 and can get refunds for the taxes you paid on them in 2025 and 2026 if you file amended returns for those years.

The 401(k) loan is also an option for some people. Your employer may allow you to withdraw more than the standard amount and give you an extra year to pay it back. Again, you must have suffered an economic loss due to a federally declared disaster to qualify. However, it’s up to the company to decide whether it wants to offer the more generous loan terms.

It’s a mixed bag

The ability to withdraw your retirement savings without penalty gives you one less thing to worry about in an already stressful situation. It’s especially beneficial to those who may have difficulty obtaining a bank loan for important expenses. Your retirement savings are always yours, so there’s no need to worry about credit checks or loan applications.

However, if you can find another way to get the money you need, it’s best to do so. Even if you pay back your disaster relief distributions, you’re still taking money out of your retirement accounts, which means you’re missing out on the opportunity to accrue returns on those funds.

This could make it more challenging for you to retire when you originally planned. When you’re able to resume saving again, you may have to set aside a lot more than you were doing so previously. Or you may have to delay retirement in order to give yourself additional time to save.

That’s why you should explore all of your options, including traditional loans, before opting for a retirement account withdrawal. If you decide to proceed one, take out only as much as you need and be careful not to exceed the $22,000 limit.

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