By Ryan Guina
Posted in Articles
Individual retirement arrangements (IRAs) are one of my favorite ways to save money for retirement. IRAs offer great tax advantages and are accessible to almost everyone. However, until not too long ago, the rules prohibited some military members from contributing to IRAs if all of their income came from a tax free deployment zone. It wasn’t intentional, of course. Congress wouldn’t want to prohibit military members from being eligible for one of the best retirement options around. Let’s take a quick look at how this happened, and what Congress did to fix the problem.
Both the traditional and Roth IRA have their own set of contribution rules, however they share a common rule regarding income eligibility: money use for contributions must be made from taxable income. This means that money contributed to an IRA must come from earned income that is taxed. This would include wages, self-employment, salaries, bonuses, commissions and even tips. It would exclude income such as royalties, rental income and in the case of military members combat wages that are free of tax. Unfortunately, many military members who spend an entire year in a tax-free zone were excluded from being eligible for an IRA because they didn’t technically have “earned income.” That’s great for tax reasons (avoiding federal income tax), but not so great for retirement purposes. Thankfully, Congress did the right thing to make tax-free income eligible for IRAs.
In order to make IRA contributions a reality for service men and women who receive combat pay, new legislation was written into law on Memorial Day of 2006. Before the Heroes Earned Retirement Opportunities Act was passed, servicemembers receiving combat pay were excluded from those who could contribute to an IRA based on the taxable compensation rule. The Hero Act makes it possible for deployed servicemembers to contribute to both the Roth IRA and a traditional IRA (Congress also backdated the HERO Act, allowing military members who were previously prohibited from contributing to an IRA to refile their taxes and make contributions for those tax years).
The HERO Act gives you the option of investing in either a Roth or Traditional IRA with money that has never been taxed. But even though you can invest in either IRA, a Roth is probably the way to go. Roth IRA contributions are typically made with money that has already been taxed, and the money is not taxed when you withdraw it in retirement. But remember, with the HERO Act, you are making contributions with money that was tax exempt. There is no other retirement account I am aware of that allows Americans to contribute money that hasn’t been taxed, then make tax free withdrawals in retirement age. This additional tax benefit makes the Roth IRA the best option for military members.
The HERO Act gives military members the same opportunity to recognize the benefits of IRAs as the civilian population, regardless of whether or not the military member’s income is taxable. This is a great opportunity to save and invest for retirement.