Saluting Veterans Benefits

With Veterans Day approaching, military families may want to review Uncle Sam’s policies on retirement savings for servicemen past and present. 

Anyone with a family member who gave their life in service to their country knows that the grief never quite goes away. What they may have overlooked or not realized, though, is that they have the ability to roll all or part of a military death benefit payout directly into a Roth IRA. This is one of the many provisions of The Heroes Earnings Assistance and Relief Tax [HEART] Act. Although the legislation was signed into law by President George W. Bush nearly a decade ago, most are not familiar with the several provisions for military service personnel that affect retirement accounts, so there’s a risk that they may not use it properly. Let’s start with fallen heroes.

“Rolling” Death Benefits to a Roth IRA
The HEART act allows for the entirety of a service member’s life insurance policy, plus an additional $100,000 for a combat-related fatality, to be “rolled,” tax free, directly into a Roth IRA or Coverdell Education Savings Account (ESA).

When a member of the armed forces dies, his or her heirs are often the beneficiaries of the Service Member’s Group Life Insurance [SGLI] policy–which can be upward of $400,000, tax free, to the beneficiary. This provision allows a beneficiary who receives life insurance proceeds through the SGLI program to fund or, more specifically, make a qualified rollover of an SGLI payment to either a Roth IRA or an ESA. Moreover, the rollover is accomplished without regard to the annual IRA/ESA contribution limit.

In the event of a nonqualified Roth IRA distribution, the amount of the distribution attributable to life insurance proceeds will be characterized as basis and can be distributed at any time without being subject to income tax or penalty. However, an early (nonqualified) distribution of earnings will be subject to taxes and penalty if the individual is under the age of 59½ at the time of the distribution (and no exception applies). It’s important to note that the rules state that to be eligible to receive this special tax treatment, Roth IRA or ESA funding must be made within one year of the date that the beneficiary receives the military SGLI.

Notably, the rollover provision, unlike the 10% penalty exception (covered next), applies to both beneficiaries (of active reservists) as well as active reservists themselves.

Special Tax Treatment of Qualified Reservist Distributions
Distributions from IRAs and salary deferrals from a 401(k), 403(b), or 457(b) plans to military reservists taken before reaching age 59½ are exempt from the 10% early distribution penalty if the reservist is called to active duty for more than 179 days, and the distribution is taken between the date of the call up and the end of the active duty period, although the funds withdrawn continue to be subject to ordinary income taxes. However, a portion or all of the funds withdrawn may be “re-contributed” or repaid during the two-year period starting on the day after active duty is ended. Although multiple repayments may be made, repayments may be made only to IRAs, even if the distribution came from an employer plan. For example, a qualifying distribution taken by a reservist in 2017 whose active service ended on February 14, 2018, can be repaid to an IRA up to February 14, 2020.

Notably, upon repayment, the individual is not eligible for a deduction in the amount repaid to the account. Therefore, in order to avoid have aftertax dollars in an IRA, consider making the repayment to a Roth IRA. Repayments made to a traditional IRA create  basis requiring the owner to track and report aftertax dollars on IRS Form 8606. The repayment amount is not subject to the annual $5,500 Roth IRA contribution limit or income test-determining eligibility.

To comply with Treasury Department regulations, we inform you that, unless otherwise expressly indicated, any tax information contained herein is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or any other applicable tax law, or (ii) promoting, marketing, or recommending to another party any transaction, arrangement, or other matter.

The information is being provided for general educational purposes only and is not intended to provide legal or tax advice. You should consult your own legal or tax advisor for guidance on regulatory compliance matters. Any examples provided are for informational purposes only and are not intended to be reflective of actual results.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett's products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

Traditional IRA contributions plus earnings, interest, dividends, and capital gains may compound tax-deferred until you withdraw them as retirement income. Amounts withdrawn from traditional IRA plans are generally included as taxable income in the year received and may be subject to 10% federal tax penalties if withdrawn prior to age 59½, unless an exception applies.

A Roth IRA is a tax-deferred and potentially tax-free savings plan available to all working individuals and their spouses who meet the IRS income requirements. Distributions, including accumulated earnings, may be made tax-free if the account has been held at least five years and the individual is at least 59½, or if any of the IRS exceptions apply. Contributions to a Roth IRA are not tax deductible, but withdrawals during retirement are generally tax-free.

A 401(k) is a qualified plan established by employers to which eligible employees may make salary deferral (salary reduction) contributions on an after-tax and/or pretax basis. Employers offering a 401(k) plan may make matching or nonelective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings accrue on a tax-deferred basis.

A 403(b) plan is a retirement savings plan that allows employees of public schools, nonprofit, and 501(c)(3) tax-exempt organizations to invest on a pretax and or Roth aftertax basis. Contributions to a 403(b) plan are conveniently deducted directly from your paycheck. In addition, your employer may elect to make a contribution on your behalf.

A 457(b) is a nonqualified, deferred-compensation plan established by state and local governments, tax-exempt governments, and tax-exempt employers. Eligible employees are allowed to make salary deferral contributions to the 457 plan. Earnings grow on a tax-deferred basis and contributions are not taxed until the assets are distributed from the plan.

A Coverdell Education Savings Account (ESA), formerly known as an Education IRA, is an attractive tax-advantaged college saving vehicle that allows an investor to save and pay for higher education for the account beneficiary (typically a child).