Interest From Savings Taxable Even for Retirees
QUESTION: I hate my job and would like to quit next summer when I reach 61 and still have my sanity. I want to live off the interest from my savings until I reach age 63 and then take Social Security and my company retirement. I expect the cash flow from the interest on my savings would give me about $16,000 a year to live on. If this interest is my only income, will I still owe federal and state taxes?--P. T.
ANSWER: Your actual tax obligation will depend on a variety of factors, but you will be required to file a tax return declaring the $16,000 or so in interest as your annual income. Interest income is not exempt from taxation. Basically, a single person under age 65 with an annual income of $4,950 or more must file a tax return. However, your final tax bill will be based on your adjusted gross income, a figure that is calculated by subtracting your allowable deductions from your total annual income.
Q: I am a permanent resident of the United States. I am about to receive an old-age pension from England, and it will be deposited for me in a bank in England. Do I have to report this income on my income tax form in the United States? Also, do I have to declare interest and dividend income I receive on my bank accounts in England on my U.S. tax form?--R. C.
A: Yes, you probably do. Our tax advisers say the general rule for permanent U.S. residents is that all income is taxable in the United States, regardless of its source. Nevertheless, if your pension is taxed in England, it is possible that your tax obligation in the United States will be forgiven. Whether or not taxes paid on foreign earned income to another country can be forgiven in the United States depends on the exact tax treaty our country has with the foreign country. If your pension and bank account has not been taxed in England, our tax advisers say it is extremely unlikely that you can avoid taxes on it in this country.
Q: Are there any rules and regulations governing the length of time an employer has to return an employee’s 401(k) contributions after the employee leaves the company? Also, what about profit-sharing plans--how long can the company hold up distributing an employee’s share after he leaves?--G. M. B.
A: The only firm rule governing the distribution of these funds is that the first payout must be made in the year the employee turns age 70 1/2. But for this one exception, there are no rules and regulations governing all pension and profit-sharing plans.
Nevertheless, every pension and profit-sharing plan has its own set of rules spelling out how the funds are administered. Ask your company’s human resources or personnel department for a copy of the rules for your plan.
Many plans require distribution of an employees’s share of the fund at the end of the year in which the employee leaves the company. Other plans set the payout date at the end of the operating year of the pension or profit-sharing plan.
In rare instances, the payout date does not occur until the employee reaches age 65. However, in general, our consultants say that it is not uncommon for an employee to wait for a full year for complete distribution of pension and profit-sharing funds.
Q: I work part time at a department store and participate in the company’s profit-sharing plan. Last year my total earnings were $12,000. Am I still eligible to put $2,000 into an individual retirement account for 1988?--M. C. B.
A: Now that we’ve officially entered the new tax season, it’s time to review--once more--the rules governing IRAs.
Basically, the law allows a single worker whose adjusted gross income is $25,000 or less to contribute as much as $2,000 to an IRA and receive a full tax deduction for the contribution. A single worker with adjusted gross income between $25,000 and $35,000 may still establish an IRA and receive a partial deduction for contributions to the account. For example, a single worker earning $30,000 would be allowed to deduct up to $1,000 of the amount contributed to an IRA. The deduction is phased out completely once workers earn $35,000 per year.
Married workers with a combined adjusted gross income of $40,000 or less are permitted a full tax deduction for their contributions to an IRA. If both spouses work, the total deductable contribution would be $4,000. If only one spouse works, the deduction would be $2,250. The allowed deduction is reduced as the family’s adjusted gross income rises and is phased out entirely at $50,000.
When Congress imposed income limits on the deductibility of IRA contributions in 1987, critics complained that the changes made IRAs most attractive to the people who could least afford to contribute to them: lower-earning workers who need as much money as possible to meet monthly expenses. However, IRA experts advise workers that they should still open an IRA even if they can’t afford to make the full tax-deductible IRA contribution allowed. You have until April 15 to open or contribute to an IRA for the preceding year.
One last note: Contributions to IRA accounts are not tax-free. They are tax-deferred. Confusion often arises because you do not pay income tax on the contributions for the year you actually earn the funds. However, when you withdraw from these accounts, you will be taxed. But because retirees generally fall into a lower tax bracket than a full-time working adult, your tax liability on the withdrawal should be lower than it would be in the year you actually made the contribution.
Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Please do not telephone. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.
