Monday, February 7, 2011

Well Deserved Special Tax Breaks for Military Personnel

Military personnel get special, well-deserved tax breaks, as outlined in IRS Publication 3, “Armed Forces Tax Guide.” Some provisions include the exclusion from gross income of combat pay and some other allowances and payments, the ability to use combat pay as earned income for the Earned Income Tax Credit, the deductibility of certain moving expenses, the ability of families of fallen soldiers to take advantage of tax-favored accounts, and tax forgiveness for those who are wounded or die in active service in a combat zone.

In addition, the Heroes Earnings Assistance and Relief Tax (HEART) Act, signed into law on June 17, 2008, created an exception to the 10% early withdrawal penalty for active military reservists taking distributions from IRAs or withdrawals of elective deferrals from 401(k) and 403(b) plans before age 59 ½. These payments are penalty free if the reservist was called to active duty after September 11, 2001 and the distribution is taken between the date of their call up and the end of their active duty period. The amount of the distribution can be repaid to the retirement plan within two years of the end of the reservist’s active duty period. When the funds are withdrawn from an IRA or employer plan under this exception they are subject to income tax and are not deductible when repaid to the IRA or plan. In order to avoid having after-tax (non-deductible) amounts in either a plan or a traditional IRA, the repayment should go into a Roth IRA. The repayment is not subject to the annual contribution limits or the income limits for making Roth IRA contributions. Other benefits to depositing the funds into a Roth IRA are that all future growth on the funds will be income tax free (provided certain conditions are met) and the account owner will have no required minimum distributions to take during his or her lifetime.

Another provision in the Heart Act allows military death gratuities and Service Members Group Life Insurance (SGLI) proceeds to be contributed to a Roth IRA or a Coverdell Education Savings Account (ESA). Unlike the 10% early distribution penalty exception described above, this provision applies to the beneficiaries of all deceased military personnel, not just those of active reservists. The contribution can be made without regard to the annual contribution or income limits normally applicable to Roth IRAs. The contribution must be made within one year of the receipt of the death benefit.

Finally, thank you to all the men and women serving in our military here at home and overseas for protecting our safety and keeping our freedom secure.

By IRA Technical Consultant Marvin Rotenberg and Jared Trexler
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