HEART Act Provides
Significant Tax-Saving Opportunity

New HEART Act Helps Military Survivors
Provide for Retirement, Education

This could well be one of the most beneficial pieces of legislation ever enacted for the financial welfare of military families who lose loved ones as a result of (or while in) military service.

A recent amendment to tax law, the Heroes Earning Assistance and Tax Relief (HEART) Act of 2008, allows survivors of fallen service members to roll their military death gratuities and/or life insurance proceeds (SGLI) into certain tax-advantaged accounts for retirement or education. This gives military families a new way to make the best of a tragic situation, and allows the deceased service member to continue to provide for his loved ones.

For those grieving the loss of a loved one, the law opens a new realm of possibilities for their future financial security.

It gives military families who have lost a loved one in military service a significant advantage in providing financial security for their lifetime.

But survivors should step carefully when deciding whether to take advantage – a total rollover isn't always the right move.

On the other hand, NOT rolling over a large portion of these payments would be a serious mistake, in our opinion.

If you find yourself in the situation of having lost a loved one and receiving payment of these military death benefits, including life insurance (SGLI), DO NOT miss this unique, once-in-a-lifetime opportunity to create financial security for your family.

It is unlikely that you will ever receive another single opportunity that has the potential to make such a difference in your family's financial future, unless you happen to be lucky enough to win the lottery, which isn't very likely.

Section 109 of the new act - "Allows a tax-free rollover of any military death gratuity and any group life insurance payment to a survivor's Roth individual retirement account (Roth IRA) or to an education savings account."

Big Opportunities

When a service member dies, the surviving family often receives substantial benefit proceeds from the government. The payout consists of the default $400,000 from Servicemembers' Group Life Insurance (SGLI) (which is automatic unless the service member 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 present an overwhelming challenge for families in the midst of suffering.

Most military families (like most other families) typically do not have the financial knowledge to properly take advantage of this new benefit. Finding a knowledgeable financial adviser to assist you is crucial to preserving the benefits this new law creates.

Most families (not just military families) who receive a sudden payment of a large amount of cash are unable to maximize the benefit because they don't know how. They suddenly start spending like millionaires, and within a few years, the money's all gone, and they're usually in the same position as before, or even worse, and unable to make ends meet. How many stories have you read about lottery winners who are penniless again in just a few years?

It is critical that military families in this situation find a qualified financial adviser to help them make sure this money is properly invested to provide for their family's future.

The new law, part of the Heroes Earning Assistance and Tax Relief (HEART) Act of 2008, gives survivors an easy way to put the money to good use immediately in a Roth IRA or Coverdell Education Savings Account (CESA).

Under normal circumstances, these accounts have relatively low annual contribution limits (usually $5,000 or less), but military beneficiaries can now bypass those rules by rolling some or all of their proceeds to either or both accounts. This is a HUGE benefit for military families!

In addition to providing families a simple solution for investing the money, the rollover move offers tax advantages that are potentially enormous. Unlike other investments, money in a Roth IRA or a CESA grows and compounds in a tax-deferred account and is generally not taxable upon withdrawal, making them truly tax-free.

The Roth IRA and the CESA are two of the best tax loopholes Congress has ever created. They allow you to build a large "nest egg" that grows totally tax-free. For most of us, that means an additional 25-40% or so every year. When the earnings are distributed in accordance with the regulations, the distributions are tax-free.

So when the money is needed for retirement or education expenses, there's likely to be much more of it than if it had been invested in a taxable account.

For an example of the increased value of a tax-free Roth IRA as opposed to a traditional taxed account, plug your numbers into this calculator, and be prepared to be amazed.

Depending on various factors (including your age, the starting balance and annual contributions, anticipated return, and your tax rate), the balance in a Roth IRA at retirement age can be more than twice that in a traditional taxed account.

Just in case you're thinking it's not worth your effort to click on the link above to check it out, let me share one example with you.

Let's say a young widow, age 29, gets appropriate investment advice and decides to deposit $400,000 into a Roth IRA, taking advantage of the provisions of the HEART Act, and keeping $100,000 in shorter term investments to help make ends meet or cover unexpected emergencies (notice I said "investments," not in her checking account, where it's far too easy to spend). Let's say she has an effective tax rate of 25% and her investment averages a 9% return annually.

If she put that money in a regular investment account (not an IRA) and never made another deposit, when she's ready to retire at age 65, the value of that account would be $4,200,927! That's a pretty impressive number by itself.

But if she takes advantage of the HEART Act and puts the same amount of money into a Roth IRA, with the same rate of return and effective tax rate, when she retires at age 65, that account will have grown to $8,900,490!

That's an EXTRA $4.7 million that Congress just awarded to this young widow by giving her the opportunity to invest these proceeds in a Roth IRA! (Obviously, if any of the factors change, such as age, tax rate, or amount invested, all the calculations change. This is a hypothetical example, and does not represent the performance of any specific investment.)

Not Right for Everyone?

For some recipients, the new rollover rule provides an opportunity to attain their retirement or college savings goals with one massive contribution. Many families, however, should think twice before devoting their entire benefit payment to a Roth IRA or CESA. Because, simply put, once the money is in, you can’t change your mind.

Each account has specific rules about when and how the money can be used. For example, withdrawing any Roth IRA earnings before age 59 ½ could result in a 10 percent penalty on top of ordinary income taxes. And a CESA can only be tapped for qualified education expenses such as tuition and books.

These limitations are significant for survivors who may need the extra money for different purposes. Most service members engaged in combat are men under age 40, and many have young children. Their families, who counted on their income for support, are likely to need immediate help covering daily expenses like groceries and mortgage payments. If too much money is tied up in inaccessible accounts, they may be stuck in a tough position.

This assessment fails to mention that although withdrawing earnings may result in penalties and taxes,contribution amounts can generally be withdrawn without tax or penalty. And if you need the funds for an emergency, and are able to replace them within 60 days, you can do so as a rollover. Such rollovers can be done only once in any 12-calendar-month period, however. And remember that any money that you withdraw will significantly reduce the amount of earnings you would have over the passage of time. See why you need to set up a Roth IRA, even if the HEART Act doesn't apply to you.

Other Options

Thankfully, the new law under the HEART Act isn’t an all-or-nothing proposition. Families who receive the death-related benefits have the choice to roll over a portion of their funds to a Roth IRA or CESA, and reserve the rest for lifestyle or unforeseen expenses. Allocating the money to several different places might make the transaction a little more complicated, but it could also help to ensure the family will be protected in every scenario.

Whether investing for long-term goals, drawing money for everyday needs, or a combination of both, it’s important for anyone with a sudden windfall to have a plan of action. Managed irresponsibly, even $500,000 can disappear into thin air with little to show for it.

A financial planner can help determine the top priorities and recommend strategies that apply to the family’s overall financial picture. Even before saving and investing, for example, it may be wise to pay off outstanding debts and establish appropriate levels of insurance.

As a general proposition, we definitely recommend paying off debts first, with the possible exception of a mortgage, because it doesn't make much sense to invest money at even 8 or 9% if you're paying a higher interest rate than that on credit card debt. If you're paying 18% on credit card debt, and investing at 8%, you're losing 10%!

And if your family has already lost one parent, you want to make sure there's adequate life insurance on your life to provide for their future, too. A properly qualified financial adviser can help you decide on the appropriate level of life insurance for your family and your particular circumstances. Remember, if you ask an insurance agent, he makes a commission on any policy you buy, so what's he going to recommend?

You may also want to consider investing in long-term care insurance, in the event you become ill, injured or disabled and require at-home nursing care or residential nursing home care. Again, a qualified financial adviser can assist you with that decision.

Remember that some financial advisers are compensated by way of commissions on the various investment and insurance products they sell you. Our recommendation is that you find a financial adviser that charges either a flat fee or an hourly fee to work with you on your financial plan, so that their compensation isn't dependent on selling you financial products or investments you may not need or understand. Always ask a financial adviser how he or she gets paid, so you can make an informed decision.

We recommend you contact a Certified Financial Planner at USAA. They work on salary and not a commission basis, so you can be confident that there is no conflict of interest. They'll recommend the solution that's best for you, not the one that makes the most commission for them.

It goes without saying that no amount of money can replace a lost loved one. But the government's latest move, paired with smart financial decisions, can make it easier to honor their memory with a life well-lived.

The portions of this article in regular type were written by June Walbert, LTC, U.S. Army Reserve, who is a CERTIFIED FINANCIAL PLANNER (TM) practitioner with USAAFinancial Planning Services, one of the USAA family of companies.

Our comments are in italics, to make it clear which is which.

The provisions of the HEART Act are generally effective for payments made for deaths occurring on or after 17 June 2008. In addition, the provision permits the contribution to a Roth IRA or a Coverdell education savings account of a military death gratuity or SGLI payment received by an individual with respect to a death from injury occurring on or after October 7, 2001, and before the date of enactment of the provision if the individual makes the contribution to the account no later than 17 June 2009.

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