Q&A: Loans on 401(k) Plans Due to Natural Disasters

By Jeanette Coleman, SPHR & SHRM-SCP on Apr 30, 2024
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In the face of natural disasters, employees often face significant financial challenges and may need to access emergency funds. One way to provide financial assistance is through a 401(k) loan. Below, we outline what employers need to know about facilitating such loans under current regulations.

Can Employees Affected by Natural Disasters Take a 401(k) Loan?

Question

One of our employees has been significantly impacted by a natural disaster and has inquired about a 401(k) loan to help cover expenses. Is this possible?

Answer

Yes, it is often possible.

The IRS periodically announces streamlined procedures for loans and relaxed rules for hardship distributions from employer-sponsored 401(k) plans following major disasters. These provisions are designed to aid employees (and certain family members) who live or work in federally designated disaster areas.

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Determining Eligibility

Your plan administrator can verify if an employee's residence or workplace is within a disaster area designated by the Federal Emergency Management Agency (FEMA) for individual assistance. Employees must confirm that the affected address was their primary residence or workplace at the time of the disaster.

Eligible employees may then borrow up to the statutory limits from their qualified retirement plans, which is generally 50% of the employee's vested account balance or $50,000, whichever is less. If the vested account balance is less than $10,000, the maximum loan amount is $10,000.

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Benefits of Streamlined Procedures

Streamlined procedures allow impacted employees quicker access to their funds and may permit the use of these funds for expenses that are not typically covered by hardship distributions, such as temporary housing and essential living supplies.

Employees may also be exempt from some pre-distribution documentation requirements and the six-month suspension of contributions that normally follows a hardship distribution.

Duration of Relaxed Procedures

These relaxed procedures are usually available for a specific period following the disaster, as specified by the IRS.

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Plan Amendments Required

If your retirement plan does not already allow these loans or hardship distributions, it must be formally amended. This amendment must be made by the end of the first plan year following the disaster.

Loans for Employees Outside the Designated Disaster Areas

Employees who live or work outside the designated disaster areas but have dependents affected by the disaster may also be eligible for a loan or hardship distribution.

RELATED: Bracing for Impact - Tornado Preparedness in the Workplace >>

Tax Implications

Employees should be aware that loan proceeds are tax-free if repaid within five years. Hardship distributions, on the other hand, are included in the employee’s gross income and may be subject to a 10% early withdrawal penalty, unless the funds consist of already-taxed contributions.

Next Steps

It is advisable for employers to work closely with their plan administrators and legal counsel to review any IRS announcements, plan documents, and applicable regulations to ensure they are providing the best possible support to their employees during natural disasters.

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