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Sunday, July 7, 2024

Helping Some Taxpayers But With Much Complexity - SECURE Act 2.0 Sec. 115 Emergency Withdrawals

picture of hospital emergency door

SECURE Act 2,0 with over 60 provisions mostly all related to retirement plans, was enacted December 29, 2022 as part of the Consolidated Appropriations Act, 2023 (P.L. 117-238). I maintain a table of the provisions, summary from the Senate Finance Committee of each provision, effective date, and any guidance from the IRS.

SEC. 115 of the SECURE Act is called "Withdrawals for Certain Emergency Expenses." It is well-intended to allow individuals to withdraw up to $1,000 from their eligible retirement account every three years without the 10% additional tax of IRC §72(t), if the funds are for distributions used for certain emergency expenses, to meet “unforeseeable or immediate financial needs relating to necessary personal or family emergency expenses.”  SEC. 115 is on pages 838-839 of P.L. 117-238.

IRC §72(t)(2)(I) covering this additional tax exception is 504 words long and in addition to defining emergency expenses, also provides:

  • The individual may only make one distribution per year, and it may not exceed the lesser of $1,000 or “an amount equal to the excess of “(I) the individual’s total nonforfeitable accrued benefit under the plan (the individual’s total interest in the plan in the case of an individual retirement plan), determined as of the date of each such distribution, over ‘‘(II) $1,000.”
  • The plan administrator may rely on employee’s written certification that the exception is met.
  • The IRS can issue regulations where the employee statement doesn’t apply if the administrator “has actual knowledge” contrary to the certification, and procedures to address cases of employee misrepresentation.
  • The taxpayer can repay the distribution within 3 years. 
  • No further emergency distributions are allowed during the 3-year repayment period unless repayment occurs.
  • Effective for distributions after 2023. See my table to see that there are a variety of effective dates for SECURE Act 2.0 provisions.

For more details, in addition to §72(t)(2)(I), see Notice 2024-03 (12/20/23) and Notice 2024-55 (6/20/24). Notice 2024-55 is 26 double-spaced pages but also covers another SECURE Act 2.0 exception to the 10% additional tax for domestic abuse victim distributions (SEC. 314). Also see IR-2024-170 (6/20/24).

Well, the idea sounds good. If someone has an emergency needing up to $1,000 of cash and the only source is a retirement plan, why not pull some funds out without the 10% penalty ("additional tax"). Now, the distribution will be taxed leaving less than $1,000 for the emergency. We might ask why only $1,000 which isn't enough to cover many emergencies. I think it is because the purpose of the account is for retirement.

Is this provision worth the 504 words in the Code, lengthy notice, future regulations and efforts by plan administrators to get the required statement that the withdrawal is for the right purpose (likely to be noted on the Form 1099-R)? It is also likely that similar to qualified charitable distributions (QCDs), it will not be noted on Form 1099-R because the administrator won't know if the individual pulled emergency withdrawals from other retirement accounts. While being able to return the funds to the account within three years (and getting a refund of taxes) is good, it adds complexity to recordkeeping for the owner and plan administrator.

I know this may seem harsh, but it would be simpler to not have this exception. But, there are often no other sources for someone in need to use this provision, unless family and friends or an employer can help. Could this be simpler?  Yes, just leave it as $1,000 over 3 years unless repaid (remove the alternative calculation). Trust the individuals declaration without the need for regulations to address when an individual might be lying. How many people are really going to lie to avoid the 10% penalty and harm their retirement funds?

Other simplifications?  What do you think?

Another note: I like the Cornell Law School Legal Information Institute website for accessing all laws. But, I remind students and practitioners that it is not always up to date. You will not find §72(t)(2)(I) at the Cornell Law School listing for §72 even though the  note at the bottom of the page lists P.L. 117-238 and SEC. 115 (their publication of §72(t)(2) goes from (H) to (L)). You can find the text in the public law or at the US Code webpage for the Office of the Law Revision Counsel at the House of Representatives website (enter Title 26, Section 72).


Anonymous said...

I've been waiting for you to comment on Chevron

21st century taxation (Annette Nellen) said...

Thanks for the comment. I'm still reading the Loper decision and thinking about regs that might have some issues and thinking about the state tax relevance as Chevron has also been cited in state tax rulings.