Tax-Deferred Savings Plans a ‘Cruel Hoax,’ Study Says

Tax-deferred savings plans such as IRAs have become a “cruel hoax” for many retirees who find themselves subject to higher income tax rates than when they were young, according to a private study released Tuesday.

A report from the National Center for Policy Analysis, a nonprofit research group based in Dallas, said tax-deferred savings programs were designed to help working people postpone taxes until retirement, when they traditionally moved to lower tax brackets.

But because some Social Security benefits now are taxed and some elderly people pay a new surtax for Medicare coverage against catastrophic illnesses, many middle-income retirees “are discovering their marginal tax rate is up to four times higher than the rate they paid while working,” the report said.

Increases Cited

“These two taxes combined can raise the marginal tax rates of elderly retirees as much as 37 percentage points,” said Aldona Robbins, a former Treasury Department economist and a co-author of the study.

“For many people, the promise of tax-deferred savings is a cruel hoax,” the report said.

For example, an elderly widow with $24,000 of income from interest, dividends and a pension in addition to her Social Security benefits faces a 1989 marginal tax rate of 48.3%, the study said. Without the Social Security and Medicare taxes, she would be in the 15% federal income tax bracket.

The report said that in addition to today’s retirees, many younger people also would be better off avoiding tax-deferred savings programs.

Reduced Incentive

“Many workers today are avoiding a 15% income tax rate when they put money into IRAs,” Robbins said. “When they withdraw the funds during retirement, they may be taxed at a rate that is three to four times higher.”

The report warned that the higher tax rates for the elderly jeopardize the nation’s ability to stimulate the personal savings needed to fuel investment in the U.S. economy and increase productivity.

“To the degree that government confiscates income from savings, the incentive to save is reduced for everyone--old and young,” it said.

The study recommended abolishing both the Social Security and Medicare taxes or at least changing the tax treatment of retirement savings, perhaps by allowing people to pay taxes on deposits to savings programs at the point when their marginal tax rates are lower.

Under the 1983 Social Security revisions, half of Social Security benefits are subject to federal income tax if half the benefits plus all non-Social Security income exceed $25,000 for an individual or $32,000 for a couple. For these people, 50 cents of Social Security benefits is taxed for each dollar of additional income.

The Medicare surcharge for the elderly was approved by Congress last year to help finance coverage of catastrophic illnesses. In 1989, a 15% surtax is imposed on federal income tax liabilities over $150, affecting about 40% of those 65 and older, with the surtax rising to 28% by 1993. The maximum surtax payment is capped at $800 per person in 1989 and rises to $1,050 in 1993.