Special Tax Rule for Families of a Fallen Servicemember

As a widow of a fallen servicemember, there is a financial planning move that should be considered in the first year after your husband’s death. Families are often the beneficiaries of the Servicemembers Group Life Insurance (SGLI) Policy. Individuals automatically insured under “full-time SGLI”:

• Active duty member of the Army, Navy, Air Force, Marines, or Coast Guard
• Commissioned member of the National Oceanic and Atmospheric Administration (NOAA) or the U.S. Public Health Service (USPHS)
• Cadet or midshipman of the U.S. military academies
• Member, cadet, or midshipman of the Reserve Officers Training Corps (ROTC) engaged in authorized training and practice cruises
• Member of the Ready Reserve or National Guard and are scheduled to perform at least 12 periods of inactive training per year
• Service member who volunteers for a mobilization category in the Individual Ready Reserve (IRR)

Though coverage amounts may vary, the payout consists of the default $400,000 from SGLI (automatic unless the servicemember opted for less coverage), plus a “death gratuity” of $100,000 for those who died while on active duty. While the money can help replace the loss of income, managing the sudden influx of cash can also represent an overwhelming challenge for families, especially while in the midst of suffering. The HEART Act of 2008 provides special tax benefits, allowing you to roll some or all of your proceeds into certain tax-advantaged accounts for retirement or education purposes. This law can add a significant amount of possibilities for your financial independence.

Your family may have cash-flow planning considerations, such as help covering daily expenses, groceries, and mortgage payments. Work with your financial advisor to assess the immediate needs, paying-off outstanding debts, establishing appropriate levels of insurance, then identify what can appropriately be put into long-term retirement and education planning.

For those funds you are allocating to retirement or education, here are key things to know about the investment rules for funds from SGLI (regarding the HEART Act). These proceeds are permitted to be invested (some or all of the funds) into a Roth IRA or Coverdell Education Savings Account (CESA). Both, are powerful financial planning tools to help manage your financial future. Unlike other investments, money in a Roth IRA or a CESA has the potential to grow and compound in a tax-deferred account and is generally not taxable upon withdrawal. Here is an example to quantify this powerful opportunity:

SGLI Contribution:

Results:

The estimated value of this Roth IRA at the time of retirement is $3,202,974. In comparison, the estimated value of a similar taxable investment at the time of retirement is $1,798,436 (based on a current marginal tax rate of 25%).

This results in the remarkable increase of $1,404,538 at retirement by contributing it to a Roth IRA instead of keeping it in a taxable account.

As a SGLI beneficiary, here are the key facts you need to know:

• You have one year from the date you receive an SGLI and/or military death gratuity benefit to roll funds to your ROTH IRA or CESA.
• Under normal circumstances, Roth IRA or CESA have annual contribution limits. Proceeds from SGLI or military death gratuity benefit bypasses these limits.
• The proceeds go into your Roth IRA as a contribution. Withdrawals are allowed, tax-free and without penalty, at any time, up to the amount of the initial contribution. (If you are under age 59 1/2, only the amount of earnings you withdraw over and above your contributions may be subject to income tax plus a 10% penalty – some exceptions do apply.)
• Distributions from Coverdell ESAs are tax-free when funds are used for the beneficiary’s qualified education expenses. Otherwise, they are subject to penalties and taxation similar to qualified retirement plans.

Don’t let the seeming complexity keep you from understanding the mechanics of this tax benefit Congress has carved out just for military widows. You can do this. Collaborate with a financial planner who can do the heavy-lifting and run the calculations for you. This law, paired with smart financial decisions, can at the very least make it easier for you to honor his memory with a life well-lived.

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of Laura Amendola and not necessarily those of Raymond James. The information has been obtained from resources to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Investing involves risk and investors may incur a profit or a loss regardless of strategy selected. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional. The example provided in this material is hypothetical and for illustrative purposes only. It does not represent an actual investment. Actual investor results will vary.

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