Most Retirees Would Benefit From Tax Plan
For millions of retired Americans, President Reagan’s tax reform package would grant generous savings, making it possible for a couple over 65 to receive nearly $20,000 in income without paying any federal income tax.
For working people trying to put money aside for retirement, on the other hand, the Reagan plan could be a big disappointment. Retirement savings in some special tax-sheltered accounts that now can be tapped for emergencies or other pressing needs would become virtually untouchable under the tax reform plan. It would slap a 20% penalty tax on money withdrawn from these accounts before retirement age.
‘Price Is Too Heavy’
“It will be possible to touch the money, but at a very high price,” said Harold Dankner, a partner at Coopers & Lybrand, a major accounting firm. “In my view, the price is too heavy and could discourage people from saving through these vehicles.”
As these two examples illustrate, what is true of the Reagan tax plan for other Americans is also true for the elderly: It would mean different things for different people, but on the whole it would add up to a modest but not insignificant reduction in the federal tax burden for most of the nation’s older citizens.
For those already retired, the Reagan plan holds out the lure of reduced taxes, with a particular break going to those with low and moderate incomes. And those who receive little or no Social Security income generally would benefit more from the change than those who rely heavily on Social Security.
Social Security benefits are already largely untaxed, and that would remain the same under the Reagan plan. Half of benefits would continue to be subject to the income tax for individuals with income of more than $25,000 and for couples with income of more than $32,000.
But many other special tax features for the elderly would be changed. While the personal exemption for each taxpayer is expected to be $1,080 next year under current law, a person 65 and over gets an extra exemption for a total of $2,160. If the Reagan tax plan is approved, the exemption would become $2,000 for taxpayers of all ages.
The tax credit for the elderly, which particularly benefits those with no Social Security income, would be equal to 15% of income under the Reagan plan, with a maximum credit of $1,725. That would be an increase from the current maximum of $1,125. This special credit enables those over 65 to receive a higher income than other taxpayers before they begin paying taxes.
“The winners will be the moderate- and low-income elderly,” a staff member of the House Aging Committee said.
Some Would Lose
Possible losers would include the relatively high-income elderly who would not qualify even for the expanded tax credit: single persons with at least $7,000 in Social Security benefits or $25,000 in other income and couples with at least $11,500 in Social Security benefits or $37,000 in other income.
Under the Reagan plan, single persons over 65 receiving average Social Security benefits (about $6,000 a year) would pay no taxes on their first $11,900 of annual income, compared to $10,640 in tax-free income under current law. For elderly couples receiving average Social Security benefits, the tax-free level of income would be $19,500, up from $18,990 under current law.
Retired persons without Social Security would benefit even more from tax reform. The tax-free level of income for single persons over 65 would grow from $9,383 to $11,600, and couples could earn $17,667 without paying taxes instead of just $14,450, as the present law allows.
‘Best Tax Shelter’
Among other tax breaks for the elderly, Don Ercole, a tax partner at Arthur Young & Co., said Reagan’s package would preserve the “best tax shelter in the world”--the ability of someone 55 or older to sell a house without owing taxes on the first $125,000 in profits.
“It’s something everyone should do, as long as they have an assured place to move into,” Ercole said. Some people are selling their homes to their children with a right to lease the property back for the rest of their lives, he said.
But older citizens could suffer from elimination of another provision in present tax law: While the elderly make comparatively little use of the tax deduction for mortgage interest costs (many have paid off their home mortgages or reduced the balance to a small amount), they do use the deduction for local property taxes.
The Reagan program would eliminate that tax break. The loss of that deduction could be another factor in encouraging people over 55, who may be thinking about selling anyway, to unload their homes and take the tax-free profit up to $125,000.
The Reagan Administration says its tax plan is designed to encourage savings for retirement. Indeed, the maximum annual contribution by a non-working spouse to a tax-deferred Individual Retirement Account would be increased from $250 to $2,000, the same ceiling that applies to workers.
But the tax proposal draws a distinct line between long-term savings and retirement money and discourages the premature use of retirement funds.
For someone who leaves a company for another job and cashes in a retirement plan, current law eases the tax burden by allowing the worker to pay taxes as if it were earned over 10 years rather than in a single year. The taxpayer also has the option of putting the money into an Individual Retirement Account tax-free.
10-Year Averaging
The Administration’s proposal would abolish the 10-year averaging tax break. Only by putting the money into an IRA could a person getting a big sum of cash avoid paying taxes at regular rates.
However, IRAs themselves would face new restrictions. Even now, taxpayers cannot withdraw money before they reach age 59 1/2 without paying a penalty. A penalty of 10% is levied on any money taken prematurely.
In most cases, the Reagan plan would double the penalty to 20% of the amount withdrawn, although the 10% penalty would continue to apply to money withdrawn prematurely for three purposes: to buy a first home, to pay for a child’s college expenses or to live on when unemployment benefits are exhausted.
Premature Withdrawals
The new 20% penalty would apply not only to premature IRA withdrawals but to money withdrawn early from all tax-favored retirement plans. That could deal a crippling blow to salary set-aside plans, known in tax jargon as 401(k) plans, which have grown increasingly popular in recent years.
About 6 million workers are enrolled in such plans, which allow workers to set aside a part of their salaries tax-free; the money goes into retirement accounts, frequently with matching amounts contributed by employers. The maximum set-aside is 25% of salary, with a $30,000-a-year ceiling.
Under Reagan’s program, the limit would be reduced to $8,000 a year, minus any IRA contribution. A person contributing a maximum of $2,000 to an IRA could place no more than $6,000 in a salary set-aside program.
Short of waiting for retirement, workers have been able to tap their 401(k) plans without penalty under a broad definition of “hardship,” which includes home purchases, college education, unusual medical expenses or other emergencies. The new rules would impose a 20% penalty--10% for home purchases, educational expenses or living expenses during periods of unemployment--for premature withdrawal.
Tax-Deferral Device
Under current rules, said Ercole of Arthur Young, salary set-aside plans “have been a very popular tax-deferral device.” But the strict new rules discouraging early use of the money will make it much more difficult to persuade workers to tie up substantial amounts of money in such plans, he said.
“People save, knowing they can get the money if they really need it,” said David Green, a manager at the accounting firm of Touche Ross & Co. “But if they have access only at great expense, they get very nervous.”
David Certner, a lobbyist with the American Assn. of Retired Persons, said: “Wealthy people may not need to touch the money in retirement plans because they have other resources. But moderate-income people may need to get to the money earlier, before they retire, for various reasons. On the other hand, these are supposed to be retirement plans, not savings plans.”
GIVING THE ELDERLY A BREAK
Most elderly taxpayers would get a break from President Reagan’s tax reform package. The accounting firm of Touche Ross & Co. computed the impact on four taxpayers 65 or over under 1986 tax rules. Single taxpayer with income of $12,000, including $6,000 from Social Security
Current Law Reagan Plan Income $12,000 $12,000 Personal exemption 2,160 2,000 Social Security exclusion 6,000 6,000 Taxable income 3,840 4,000 Preliminary tax 151 165 Elderly tax credit 0 150 Net tax 151 15
Single taxpayer with income of $12,000, none from Social Security
Current Law Reagan Plan Income $12,000 $12,000 Personal exemption 2,160 2,000 Taxable income 9,840 10,000 Preliminary tax 1,008 1,065 Elderly tax credit 412 975 Net tax 596 90
Married couple with income of $20,000, including $11,000 from Social Security
Current Law Reagan Plan Income $20,000 $20,000 Personal exemptions 4,320 4,000 Social Security exclusion 11,000 11,000 Taxable income $4,680 5,000 Preliminary tax 111 150 Elderly tax credit 0 75 Net tax 111 75
Married couple with income of $20,000, none of it from Social Security
Current Law Reagan Plan Income $20,000 $20,000 Personal exemptions 4,320 4,000 Taxable income 15,560 16,000 Preliminary tax 1,606 1,800 Elderly tax credit 375 1,275 Net tax 1,231 525
