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Child-Only SBP Tax Trap

Military Pay and Benefits Estate Planning

In certain circumstances it may make sense to select child-only Survivor Benefit Program (SBP) coverage. One case where it may make sense is in the case of an active duty death. This is because Dependency and Indemnity Compensation (DIC) is paid to spouses and children of active duty servicemembers who die on active duty (assuming favorable Line of Duty determination). Spousal SBP benefits are reduced by each dollar received in DIC benefits. This is not the case for children receiving SBP and DIC. So, When DIC benefits are larger than SBP spousal benefits it can be advantageous for the spouse to forego SBP and elect child-only coverage. Specifically, this would occur in the case of a junior officer or many enlisted ranks. A retiring military member might chose child-only coverage to save money as well.

New Tax Law Affects SBP

The Tax Cuts and Jobs Act (TCJA) has significantly changed the treatment of child SBP benefits and that change, if unplanned for, could negatively impact military families where children receive child-only SBP.

Under the Tax Code, SBP benefits are considered unearned income and this type of income is taxed differently for children than their other income (such as wages from a part-time job). Under the old tax law, the income that exceeded approximately $2,000 was taxed at the parents’ tax rate. In the cases involving SBP benefits, somewhere around 25% or less would be the expected tax rate. Under the TCJA, a child’s unearned income exceeding $2,100 is taxed at trust tax rates. The maximum tax rate for trusts is 37% and it starts at income exceeding $12,750. So, the family unit of the deceased servicemember, could see the taxes on a good portion of their income increase by nearly 50% (37%-25%/25%). And if not planned for, a very large tax-bill due when the child's tax return is filed.

If spousal SBP benefits would be eliminated by DIC payments, child-only SBP may still be the best choice, but less of the SBP payments will be available than under the old tax law.

What Next?

If you’re still on active duty, this is something you should talk to your spouse about and make sure you remember it in case you have a loss in your unit.

There is a legislative fix working its way through Congress, but we all now how dysfunctional that legislative body is.

If nothing is done, in 2025 the TCJA expires and tax treatment of SBP payments will revert to the old rules and will be taxed at the parent’s tax rate.

If you found this article useful, you might like the following blog posts:

SBP and Long-Term Care Insurance

Military Tax Benefit: Rollover of SGLI Proceeds to a Roth IRA

To SBP or NOT SBP? That is the Question

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