In 2008, President George W. Bush signed the Heroes Earnings Assistance and Relief Tax (HEART) Act bill, which gave U.S. service members and their families many forms of financial assistance as a further means of thanking and compensating them for their service in the ongoing war against terrorism. The HEART Act contains several provisions designed to allow service members and reservists to make a smooth financial transition both into active duty and then back into their civilian lives. Military families should take care to familiarize themselves with the provisions of this bill, as it offers a wealth of benefits for those who qualify.
Roth IRA/Coverdell ESA Contribution Limit Exception
One of the most important provisions of the HEART Act pertains to retirement and education savings account contributions. The beneficiaries of service members who are killed in the line of duty are typically eligible to receive two forms of compensation. One is the death benefit from a Servicemembers' Group Life Insurance (SGLI) policy that automatically pays a maximum of $400,000 to the beneficiary of each deceased service member. The other is a military death gratuity that pays $100,000 (also automatically). The HEART Act allows (but does not require) beneficiaries to lump both of these amounts together and rollover directly to a traditional IRA, Roth IRA or a Coverdell Educational Savings Account. These contributions are permitted above and beyond the standard amounts that may be contributed to them.
A total of $500,000 may be contributed to a Roth and then be withdrawn tax-free at retirement by the beneficiaries or else used to pay for higher education expenses. This effectively constitutes the largest single tax break for retirement plan contributions in the entire code for anyone under any circumstances. A widow who receives this amount at age 40 and lets it grow inside a Roth IRA for 20 years at 5% will have over a million dollars of tax-free cash at retirement.
Other Tax Breaks
The HEART Act provisions also extend to several other areas of employer-related compensation and tax savings for service members. Some of the provisions include:
1. Required payout of additional benefits from qualified and certain other types of retirement savings plans offered by employers. Employers must treat a deceased employee who was called to active duty and killed as having resumed employment with them before death. This will allow the service member/employee's beneficiaries to receive benefits such as accelerated vesting and ancillary life insurance payouts in the same manner as they would for a deceased civilian employee who had been continuously employed at that same job.
2. Penalty-free distributions from all qualified retirement plans and 403(b) plans and 457 plans. The service member employee cannot, however, make further elective contributions into the plan for six months after the date of distribution.
3. Permanent penalty-free status of all qualified plan distributions taken by active duty reservists who are called to serve for more than 179 days. In this case, reservists are also allowed to re-contribute these amounts at a later time under certain conditions.
4. Differential pay (the difference between an employee service member's military and civilian wages) is now classified as W-2 income instead of 1099 income, which means that it will count toward the amounts that the employee service members can contribute to their retirement plans.
5. Tax-free distributions from any type of flexible-spending plan used to pay for health care expenses for qualified reservists who are called into active duty.
6. Tax-free status for any bonuses paid by states or other political bodies to service members for duty served.
7. Permanently awards tax-free combat zone pay as earned income that is eligible for the Earned Income Credit.
8. Makes the first-time homebuyer exemption permanent for veterans who use mortgage revenue bonds to purchase their residence.
9. Awards tax-free status to certain state and local payments made to service members who are also volunteer firefighters or emergency medical responders.
10. AmeriCorps participants who receive cash or other benefits will not have this income factored into the equation when calculating their SSI eligibility and benefits.
The Bottom Line
The various provisions included in the HEART Act took effect in stages. Some became effective retroactive to 2007 while other parts of the act did not take effect until 2009. But all of the provisions in this act still apply to eligible veterans and service members and their families today. For more information about the HEART Act, contact your financial advisor or military family assistance center.