Financial planners typically advise clients not to touch funds in their 401(k) before retirement, noting the steep penalties and fees associated with doing so. But for those affected by Hurricane Harvey — or in the path of Hurricane Irma — is it time to question conventional wisdom?

Advisors grappling with this question face a complicated set of issues. The government, meanwhile, has changed the calculus for some.

Last week, the IRS made it easier for individuals impacted by Harvey to access cash from 401(k) plans by streamlining the process to take out loans against those assets or withdraw them directly. Known as hardship distributions, the withdrawals are available for clients in times of need — like after unreimbursed health care costs, unexpected deaths or, in this case, natural disasters.

But drawbacks remain. Individuals under the age of 59 and a half will still be assessed the normal 10% early withdrawal penalty on top of income taxes. If a client decides to take the 10% penalty plus around 25% in income taxes, it leaves only about 65 cents on every dollar taken out.

“Certainly, it’s a last-ditch resort,” says Jonathan Cameron, a CFP with Miami-based RIA Cameron Downing. “But, if you either retire comfortably down the road or you put food on the table today — it’s sort of a no brainer.”

Though the IRS may have sped up the hardship distribution process for victims of Harvey, clients and their advisors will still wrestle with significant penalties and fees, says Therese Nicklas, a CFP with Boston-based RIA Wealth Coach for Women.

“A withdrawal is a taxable event,” Nicklas says, “and we’re probably not looking at a few thousands of dollars for minor repairs, either.”

Residents with a dog sit in the back of a truck while waiting to be rescued from rising floodwaters due to Hurricane Harvey in Spring, Texas, Monday, Aug. 28, 2017.
Residents with a dog sit in the back of a truck while waiting to be rescued from rising floodwaters due to Hurricane Harvey in Spring, Texas, Monday, Aug. 28, 2017. Bloomberg News

For that reason, Nicklas focuses on exhausting every imaginable option first, including all lines of credit and cash positions. Once that’s done, look to loans as a less harmful choice for clients, she says.

Loans have interest attached and have to be paid back, but that may well be the lesser of two evils, she says.

“It’s a lot less expensive than paying taxes on a withdrawal,” Nicklas says, “or taking a lump sum and moving into a new tax bracket.”

In officially declared disaster areas, clients may also be able tack on their deductions from casualty losses to the previous year’s return by amending that return or by filing an extended one, says Colby Trane, a tax attorney and CFP with Egan Tax & Books. That means individuals hit by Hurricane Harvey, for example, can get tax relief within months instead of waiting for the following year’s return.

“After a natural disaster in 2017, the earliest you can see that money is 2018,” says Trane. “But in officially declared disaster areas, individuals can benefit by amending their 2016 returns, especially if they’ve paid a fair amount of tax the prior year.”

A close review of insurance policies before the storm hits can help investors know where they stand in the event of serious damages, Cameron says. “What are your limits? What are you actually covered for?”

He also emphasizes that clients make digital copies of key financial documents as backups.

For Cameron, who helped board up a family member’s home in the Miami metropolitan area on Wednesday, financial security is just as important as storm proofing.

“When you don’t have electricity, cash becomes very important,” Cameron says.

Register or login for access to this item and much more

All Financial Planning content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access