Military Tax Benefit: Roll-Over Of Life Insurance Proceeds To Roth IRA
I know this is not something people like to think about, but, beneficiaries of Military Members’ Government Life Insurance Policies have a significant benefit available to them. And…in my 27 years on Active Duty, I never heard of it. I hope that you (or anyone that you know) never have a need for this benefit. But, if you do, it could improve your future quality of life. Let’s take a look at specifically what the benefit is and how you can use it.
As stated in IRS Pub 590 (http://www.irs.gov/pub/irs-pdf/p590.pdf) if you receive a Military Death Gratuity or SGLI (Servicemembers Group Life Insurance) payment as a result of a death from injury that occurred after October 6, 2001 you may contribute all or a portion of the amount to a Roth IRA. The amount contributed is treated as a roll-over and not limited in amount or by Adjusted Gross Income (AGI). Some things to note:
- The death must be the result of an injury
- The death need not be the result of combat
- The contribution must be made within one year of receiving the benefit
- If you contribute a portion of the proceeds to an Education “IRA” the amount that you can contribute to the Roth is reduced by the same amount
- The amount contributed to the Roth IRA is considered part of your cost basis and not subject to tax
A beneficiary has the potential to roll-over up $500,000 if the servicemember was insured for the SGLI full amount. The $1/2 million is comprised of up to $400,000 of SGLI benefits (amount determined by servicemember) and the $100,000 Death Gratuity (paid as a result of a death from a service connected illness or injury). Since SGLI is life insurance the proceeds are Federal Income Tax free. The Military Death Gratuity is also free from Federal Income Tax. So, a survivor of a military member who dies as a result of injuries could deposit 1/2 million dollars into a Roth IRA. And, this is where the real benefit occurs.
Income earned in a Roth IRA is free from Federal Income Tax if certain conditions are met when withdrawals are made. The two primary conditions are
- The withdrawals are made after the account has been open for 5 years (the IRS language is a little different. To make sure you don’t make a mistake, refer to Pub 590)
- The payment is made after the owner turns 59 1/2 (plus a few other special circumstances).
So, the survivor of the military member has the potential to set up a pretty good “nest egg”. But, for a lot of survivors, they may not have the financial capacity to wait. Then what? Well, there is one other rule that applies and it concerns the order that the money comes out. According to IRS rules the money comes out in this order (for determining if taxes and penalties are due).
- Regular Contributions
- Roll-overs and Conversions (taxable first, then non-taxable)
So, if the $500,000 is the only money sitting in the Roth IRA, the survivor would be able to spend the full $500,000 prior to dipping into the earnings and owing any tax or penalty. Also, a planned series of equal payments would eliminate the tax/penalty on the earnings as well. This is significant. A survivor could set up, potentially, a lifetime stream of income with no taxes due on it. This is like receiving 10-30% more in taxable income (depending on tax bracket).
If this ever does happen to you or someone you know you will want to get competent tax and legal advice. But, to know to get the advice and execute the plan you have to know the benefit exists. Like I said, I hope you never need it, but it is good to know it is there.