Most people in the military and their families are familiar with the ongoing benefits afforded to individuals who served our country, like pensions, inexpensive life insurance and retirement plans, tax-free housing allowances, and access to special savings and loan programs. However, there are some other, lesser-known financial tools of which active duty service members and veterans can take advantage.
Some of these unique military benefits came about as a result of the Heroes Earnings Assistance and Relief Tax (HEART) Act of 2008. The three main provisions of this law were:
- Service members maintain employer benefits during active duty
- Elimination of self-employment tax on “differential pay”
- Ability of survivors to invest Death Gratuity and Service-members Group Life Insurance (SGLI) into Roth IRAs and/or Coverdell Educational Savings Accounts without ordinary contribution limits
Before the HEART Act, service members, particularly those in the reserves, could be treated differently than current employees while on active duty. Now for cases in which service members cannot return to their previous employment due to death or disability that occurred while actively serving, they or their survivors are entitled to any additional death or disability benefits normally available to current employees. These can include accelerated vesting in a retirement plan, additional life insurance benefits, and potentially other survivor benefits based on the employer and plan design.
Additionally, those service members called to active duty for more than 180 days are allowed to take withdrawals from qualified retirement plans and Health Flexible Spending Accounts without being subject to the 10% tax penalty that would otherwise apply. Those who take advantage of these provisions may not make new contributions to their plan for at least six months after withdrawals are taken.
Some civilian employers choose to pay some or all of a service member’s compensation during a period of active duty. These payments to employees on active duty for more than 30 days are referred to as “differential wage payments.” In the past these were treated as self-employment income and reported on IRS Form 1099-MISC. Employers are now required to treat such payments as W-2 wages. This eliminates the need for the service member to pay self-employment tax on this income (FICA taxes are still withheld) and also allows contributions to continue to be made to the employer’s qualified retirement plan.
The HEART Act also permits surviving spouses who receive death gratuities and/or Service-members Group Life Insurance (SGLI) death benefits to invest some or all of these funds into a Roth IRA and/or a Coverdell ESA, without being subject to current contribution limits. The investment must occur within the one-year period beginning on the date when the beneficiary receives the death benefits, and the total amount contributed between a Roth IRA and a Coverdell ESA cannot be greater than the total military death benefits received.
This can be enormously impactful as death gratuities are generally $100,000 for death related to active duty and SGLI has coverage up to $400,000. This means that potentially up to $500,000 can be contributed to accounts usually subject to restrictions that would prevent such a large amount from going in at once. Keep in mind it will be important to speak with someone who has experience in having this treated and coded properly before moving forward with the investment.
Beyond the HEART Act, another nice financial benefit service members can use is the ability to contribute tax-free combat pay into a Roth IRA. Normally, Roth IRA contributions are made with after-tax dollars and then any growth is tax-free when withdrawn (subject to certain rules). This allows for the possibility of legally avoiding taxes on that money earmarked for retirement.
If you have any questions regarding an active or veteran service member, please reach out to us. In the meantime, THANK YOU to all of you who have served our country!
Content in this material is for general information only and not intended to provide specific financial, tax or legal advice or recommendations for any individual. Limitations and restrictions on Roth IRA qualified withdrawals may apply. Withdrawals prior to age 59 1/2 or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.