While many of the benefits available to U.S. military veterans are well known, service members may not realize that they are eligible to roll all or part of a military death benefit payout directly into a Roth IRA. This is one of the many features of the Heroes Earnings Assistance and Relief Tax (HEART) Act of 2008 containing powerful retirement planning provisions for former military service personnel. We’ll discuss two of them here.
“Rolling” Death Benefits to a Roth IRA
Under the HEART Act, the entirety of the up-to-$400,000 Service member’s Group Life Insurance (SGLI) policy, plus an additional $100,000 that is paid in the event of a combat-related fatality, may be rolled over directly, tax free, into a Roth IRA, effectively allowing for a $500,000 Roth contribution.
When a member of the armed forces dies, the surviving spouse is often the beneficiary of the SGLI policy, which can be upward of $400,000 and paid 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 into either a Roth IRA or a Coverdell Educational Savings Account (ESA). Moreover, the rollover is accomplished without regard to the annual Roth IRA contribution or income limit. Annual contributions to a Roth IRA are otherwise capped at $6,000 (in 2022). Notably, in order to take advantage of the provision, the rules require that the rollover into the Roth IRA (or ESA) must occur within one year of the death benefit being received. A partial contribution is permitted where some of the funds can go into a Roth IRA and some to an ESA.
Funds “rolled” into a Roth IRA are subject to the standard distribution rules that otherwise apply, including the ability to distribute contributions (basis) at any time and or age - tax and penalty free. However, earnings in the case of a non-qualified distribution may be both taxable and subject to a potential 10% early withdrawal penalty tax. In other words, 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 or age without being subject to income tax or penalty.
Generally, it’s not prudent to rollover the proceeds into a traditional IRA. This is due to the funds not being eligible for a tax deduction. Repayments made to a traditional IRA-create basis and therefore must be reported on IRS Form 8606 “Nondeductible IRAs”.
Qualified Reservist Distributions
Distributions from IRAs and salary deferrals from 401(k), 403(b), or 457(b) plans to military reservists taken before age 59½ are exempt from the 10% early distribution penalty tax 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.
Some or all of the distributed funds may be “recontributed” or repaid during the two-year period starting on the day after active duty is ended. However, when they are repaid, the individual is not eligible to take a tax deduction for the amount repaid. Therefore, in order to have after-tax (basis) in a traditional IRA the repayment should be made to a Roth IRA.
A distribution is considered a Qualified Reservist Distribution if the following requirements are satisfied:
- Called to active duty after September 11, 2001
- Called to active duty for a period of 180 days or more or for an indefinite period because you are a member of a reserve component
- Distribution was made no earlier than the date called to active duty and no later than the end of the active-duty period
Those wishing to make the most of these and other retirement-related features of the HEART Act should contact their financial professional for additional details.
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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 after-tax 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.
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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.