Wednesday, October 29, 2008
Tax tip for military families
I just came across this little gem:
Now, I say this with a bit of a caveat:
In my opinion, most military people would be better off funding a Roth IRA, if they're otherwise eligible, rather than a traditional IRA, which is the account this particular paragraph refers to.
Why?
Simple. Think of it this way: A regular or traditional IRA (I'll call them "T-IRAs for short) lets people take a tax deduction now, but forces them (or their heirs) to pay full-boat income tax when they retire. Secondarily, there are very complex and draconian requirements T-IRA owners have to follow which tell them when and how they have to take distributions...that is, receive income from the IRA.
A Roth IRA is the reverse: They pays theys' thar taxes NOW, but if they can leave the money alone until retirement, (with certain exceptions), they never have to pays thar taxes on it again EVAR!. And if a family inherits it, they can stretch out that IRA a lot longer and not have to swallow a huge income tax bill in the first five years like the families that inherit a T-IRA.
So the calculation is if you think your taxes will be higher in the future than they are now, you want a Roth. If you think your family will inherit a balance (I.e., you're a smoker, a diabetic, a skydiver, or are otherwise playing fast and loose with the standard mortality tables) you want your family to inherit a Roth, as well, rather than a traditional IRA. The IRS is hungry, and THEY WANT THAT TAX REVENUE that you deducted when you first made the T-IRA contributions, and they WILL go after your heirs to get it, and they WILL go after you if you don't take distributions according to their schedule!
Clear as mud?
Now, consider that if you drew significant non-taxable combat pay, your AGI is artificially low. Which means so is your tax bill, and probably your tax bracket.
So since your tax bracket is artificially low that year, chances are that that serviceman or woman will want to use the Roth, pay that artificially low tax, and never have to worry about getting screwed by the IRS in retirement. In essence, a military person who drew mostly combat pay in that year is funding his or her retirement account with tax free dollars - and taking it out, tax free as well. (Investment returns after fees being equal, this kicks the shit out of the Thrift Savings Program for the military, which will force you to pay full boat income tax in retirment.)
Tax wise, it's the best investment structure going!
Now, this is where it gets tricky: There's no guarantee you can qualify. Your income limits may still screw you out of the IRA or the Roth IRA, if you had significant nonmilitary income, or if your spouse works, earns decent money in the civilian world and you filed jointly. And if you blow the income limits and try to contribute anyway, the IRS WILL hunt you and your family down with an axe. Well, you'll pay a modest penalty at least.
Sit down with a tax professional and see how the above applies to your specific situation. Countercolumn does not give tax advice.
But don't expect your tax preparer to be conversant with rules as they apply to military members. Most garden variety tax preparers can barely spell IRS. You need to go in and be able to show them the regs. In this case, IRS Publication 590.
Splash, out
Jason
If you were a member of the U.S. Armed Forces, compensation includes any nontaxable combat pay you received. This amount should be reported in box 12 of your 2007 Form W-2 with code Q.
If you received nontaxable combat pay in 2004 or 2005, and the treatment of the combat pay as compensation means that you can contribute more for those years than you already have, you can make additional contributions to an IRA for 2004 or 2005 by May 28, 2009. The contributions will be treated as having been made on the last day of the year you designate. If you have already filed your return for a year for which you make a contribution, you must file Form 1040X, Amended U.S. Individual Income Tax Return, by the latest of:
3 years from the date you filed your original return for the year for which you made the contribution,
2 years from the date you paid the tax due for the year for which you made the contribution, or
1 year from the date on which you made the contribution.
Now, I say this with a bit of a caveat:
In my opinion, most military people would be better off funding a Roth IRA, if they're otherwise eligible, rather than a traditional IRA, which is the account this particular paragraph refers to.
Why?
Simple. Think of it this way: A regular or traditional IRA (I'll call them "T-IRAs for short) lets people take a tax deduction now, but forces them (or their heirs) to pay full-boat income tax when they retire. Secondarily, there are very complex and draconian requirements T-IRA owners have to follow which tell them when and how they have to take distributions...that is, receive income from the IRA.
A Roth IRA is the reverse: They pays theys' thar taxes NOW, but if they can leave the money alone until retirement, (with certain exceptions), they never have to pays thar taxes on it again EVAR!. And if a family inherits it, they can stretch out that IRA a lot longer and not have to swallow a huge income tax bill in the first five years like the families that inherit a T-IRA.
So the calculation is if you think your taxes will be higher in the future than they are now, you want a Roth. If you think your family will inherit a balance (I.e., you're a smoker, a diabetic, a skydiver, or are otherwise playing fast and loose with the standard mortality tables) you want your family to inherit a Roth, as well, rather than a traditional IRA. The IRS is hungry, and THEY WANT THAT TAX REVENUE that you deducted when you first made the T-IRA contributions, and they WILL go after your heirs to get it, and they WILL go after you if you don't take distributions according to their schedule!
Clear as mud?
Now, consider that if you drew significant non-taxable combat pay, your AGI is artificially low. Which means so is your tax bill, and probably your tax bracket.
So since your tax bracket is artificially low that year, chances are that that serviceman or woman will want to use the Roth, pay that artificially low tax, and never have to worry about getting screwed by the IRS in retirement. In essence, a military person who drew mostly combat pay in that year is funding his or her retirement account with tax free dollars - and taking it out, tax free as well. (Investment returns after fees being equal, this kicks the shit out of the Thrift Savings Program for the military, which will force you to pay full boat income tax in retirment.)
Tax wise, it's the best investment structure going!
Now, this is where it gets tricky: There's no guarantee you can qualify. Your income limits may still screw you out of the IRA or the Roth IRA, if you had significant nonmilitary income, or if your spouse works, earns decent money in the civilian world and you filed jointly. And if you blow the income limits and try to contribute anyway, the IRS WILL hunt you and your family down with an axe. Well, you'll pay a modest penalty at least.
Sit down with a tax professional and see how the above applies to your specific situation. Countercolumn does not give tax advice.
But don't expect your tax preparer to be conversant with rules as they apply to military members. Most garden variety tax preparers can barely spell IRS. You need to go in and be able to show them the regs. In this case, IRS Publication 590.
Splash, out
Jason
Labels: finance, reserve issues, retirement, soldiers' issues, taxes
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