A qualified reservist is a member of the military reserve who, although not active, can make an early withdrawal from a retirement account without the usual early distribution penalty when called to duty.
Under most circumstances, the IRS imposes a penalty of 10% on the taxable amount withdrawn from a retirement account by taxpayers younger than 59½ years old. Qualified reservists are exceptions to this rule. Still, their withdrawals are subject to federal and state taxes.
To qualify, reservists must be ordered or called to active duty after Sept. 11, 2001, for more than 179 days or an indefinite period. Withdrawals need to be either from an individual retirement account (IRA) or from employees’ elective deferrals to a 401(k), 457, or 403(b) plan. Also, the withdrawals must occurn during the period of active duty.
Certain rules allow reservists to repay these distributions during the two-year period when active duty ends, even if the repayment contributions exceed annual contribution limits.
Key Takeaways
- Qualified reservists, when called to duty, can make penalty-free withdrawals from certain retirement accounts.
- Qualified reservist rules were introduced by the Pension Protection Act of 2006 and later expanded by the HEART Act in 2008.
- Such individuals can face long-term negative impacts on retirement savings due to early withdrawals.
- Retirement withdrawals are still subject to federal and state taxes.
- Missing even a single year’s savings in a retirement account can significantly impact long-term retirement planning.
Understanding Qualified Reservists
Qualified reservist rules are relatively recent, enacted as part of the Pension Protection Act of 2006. Initially, these rules applied to active reservists on Dec. 30, 2007, or earlier. However, the 2008 HEART Act (Heroes Earnings Assistance and Relief Tax Act) extended these rules moving forward.
The HEART Act provides many forms of financial assistance to U.S. service members and their families. It contains provisions that make it easier for service members to smoothly transition both into active duty and back into civilian life.
Pros and Cons of Being a Qualified Reservist
Serving in the reserves can create financial challenges. For instance, married couples with children might face unexpected childcare costs when one or both parents are called into active duty overseas. The qualified reservist rules offer financial flexibility to tackle such situations.
On the flip side, these rules come with restrictions. Service-member employees cannot make further elective contributions to their retirement plans after the withdrawal date. This could negatively impact their overall retirement savings.
Perhaps the biggest disadvantage of the qualified reservist rules is that even missing one year of contributions to a 401(k) or IRA can significantly impact retirement readiness. This is especially critical early in the retirement savings process, as early withdrawals lose the opportunity to compound over time. Even a small withdrawal may result in a substantial reduction in the retirement nest egg many years down the line.
By understanding both the benefits and the restrictions, reservists can make more informed decisions about their financial futures.
Related Terms: 401(k), IRA, military reserves, Pension Protection Act, HEART Act.
References
- Internal Revenue Service. “Retirement Topics – Exceptions to Tax on Early Distributions”.
- Internal Revenue Service. “Publication 3 (2023), Armed Forces’ Tax Guide”.
- U.S. Government. “Pension Protection Act of 2006”.
- U.S. Congress. “Heroes Earnings Assistance and Relief Tax Act of 2008”.
- U.S. Army. “The HEART Act”.
