Veterans Day is coming in November, and there are retirement benefits for current military members who could use financial help. Financial advisers should pass this information on to clients and friends who might benefit from one of these retirement provisions.
10% PENALTY RELIEF FOR ACTIVE RESERVISTS
Distributions from IRAs or other retirement plans to military reservists taken before reaching age 59½ are penalty free 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.
REPAYMENTS PERMITTED
The provision allows the early distributions to be repaid to an IRA or employer plan within two years of the end of the reservist's active service. For example, a distribution taken by a qualifying reservist in 2016 whose active service ended on March 15, 2017 can be repaid to an IRA up to March 15, 2019.
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Repayments will have no effect on the annual contribution limits. They can be in addition to the regular contributions for that year and will not cause an excess contribution. But the repayments are not deductible, which will create basis to keep track of in the employee plan or on Form 8606 for IRA owners so that eventual distributions of these funds will be tax free. For that reason, the reservist making a repayment should consider putting the repayment funds into a Roth IRA.
CONTRIBUTING MILITARY DEATH BENEFITS TO A ROTH IRA
A beneficiary of military death gratuities and Service Members Group Life Insurance (SGLI) can contribute those funds to a Roth IRA or a Coverdell Education Savings Account (ESA). Unlike the 10% penalty exception provision, this provision applies to beneficiaries of all military personnel, not just active reservists. The Roth contribution can be made without regard to the annual contribution or income limits that apply to those accounts. The contribution must be done by the end of the year after the year of receipt of the death benefit.
Example:
Jane receives an SGLI beneficiary distribution of $30,000 and her AGI for the year will be $200,000. She will be able to contribute up to $30,000 to a Roth IRA within a year of her receipt of the benefit, even though the $30,000 is more than the annual contribution amount and her income exceeds the amount allowable for making a Roth contribution.
Many times, the beneficiaries of these payouts are young parents with children who very likely will need the funds for immediate expenses. A qualified distribution of Roth funds (one that is tax and penalty free) cannot be made until the Roth owner has held a Roth account for five years AND the account owner is 59½, dies, becomes disabled, or uses up to $10,000 of the funds for a first-time home purchase.
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However, this does not mean that the SGLI funds are locked in the Roth until age 59½ (or one of the other exceptions applies). The funds go into the Roth as a qualified rollover (basis) and can be pulled out at any time with no tax or penalty. The earnings on those funds, however, cannot. An early distribution of the earnings will be subject to income tax and the 10% early distribution penalty (if under the age of 59½).
A partial contribution of the benefits can be done. Some of the funds can go to a Roth, some to an ESA, and some can be held out for immediate needs. The total amount contributed to a Roth and an ESA cannot exceed the total amount of the benefits received. Funds are considered contributed to the ESA first and the Roth IRA second. Any excess amounts contributed would have to be withdrawn from the Roth IRA first.
Example:
Mike receives an SGLI beneficiary distribution of $250,000. He immediately contributes $50,000 to an ESA account for his son. The most Mike could now contribute to a Roth IRA is the remaining balance of $200,000 ($250,000 - $50,000). If the beneficiary receives more than one benefit, the contribution deadline applies separately to each benefit received.
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Ed Slott, a certified public accountant, created the IRA Leadership Program and Ed Slott's Elite IRA Advisor Group. He can be reached at irahelp.com.
