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 undoubtedly cover a significant chunk of that. But there are still going to be those faced with high out-of-pocket costs and no obvious place to turn.

These families can tap some of their retirement savings to pay for damages related to federally declared disasters. But there are some key rules you ought to know before you do this. Even if you're eligible, it might not be your best option.

Stressed person with hand on head sitting in car.

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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 some of their retirement savings without the typical 10% early withdrawal penalty. However, there are limitations.

First, this only applies to those who have sustained an economic loss due to a federally declared disaster. You probably already have an idea if you've experienced a federally declared disaster, but if not, 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 plans like 401(k)s or 403(b)s. The $22,000 limit applies to your maximum disaster relief withdrawals from all retirement accounts, not to each individually. These withdrawals must be made within 180 days of the later of the first date of the incident period or the date of the disaster declaration.

You'll still owe taxes on these distributions, though you're allowed to spread them out over three years rather than paying 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 in which you paid taxes on these distributions.

For example, if you took 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.

If you prefer to go the 401(k) loan route rather than a traditional withdrawal, 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 these more generous loan terms.

It's a mixed bag

The ability to withdraw retirement savings without tax penalties gives you one less thing to worry about in a stressful situation. It's especially beneficial to those who may have difficulty obtaining a bank loan for the money they need. Your retirement savings are always yours, so there's no need to worry about credit checks or traditional 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 the opportunity to accrue earnings 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 previously. Or you may have to delay retirement in order to give yourself additional time to save.

So explore your other options, including traditional loans, before opting for a retirement account withdrawal. If you decide to proceed with the IRA or 401(k) withdrawal, take out only as much as you need and be careful not to exceed the $22,000 limit.