Confusion About Retirement Income Taxes
Many middle-income Americans age 50 and over do not understand the tax rules regarding retirement savings, according to a Banker’s Life Center for a Secure Retirement survey. While 94% of respondents could correctly explain how lottery winnings are taxed, only 29% could explain the tax rules for 401(k) plans.
Withdrawals are a big area of confusion. More than half (57%) did not know the age for taking required minimum distributions IRS Publication 590 lists the exceptions and other rule clarifications.. Once a person turns 70½, he or she generally must take the first RMD by April 1 of the following calendar year.
Most respondents were not aware that, in certain cases, early withdrawals can be taken without triggering the 10% penalty. Some allowances:
- Health insurance premiums if unemployed (90% didn’t know this),
- Qualified higher education expenses (89% didn’t know this),
- Unreimbursed medical expenses in excess of 10% (or 7.5% for those born before January 2, 1949) of adjusted gross income (71% didn’t know this) and
- The purchase of a first home (84% didn’t know this).
The standard deduction was another source of misunderstanding. More than half (56%) were unaware that blindness qualified for a larger standard deduction ($1,550 extra for single filers and $1,200 extra for married couples filing jointly). Nearly seven out of 10 (68%) could not identify 65 as the age when the standard deduction increases. (It rises by an additional $1,550 and $1,200 for single and joint filers, respectively). Even the possibility of claiming a parent as a dependent was unknown by 90% of respondents. See IRS Publication 501 for the rules regarding a qualifying relative.
One possible reason for the confusion may be the lack of information shared by tax professionals. More than 60% of respondents who worked with a tax professional said they did not receive any additional guidance on tax savings tips, long-term tax strategies or how to invest tax refunds.
Source: “Retirement Tax Considerations for Middle-Income Americans,” Center for a Secure Retirement Perspective, April 2014; “The Individual Investor’s Guide to Personal Tax Planning 2013,” AAII Journal, January 2014; Internal Revenue Service.