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 RMDs. Once a person turns 70½, he or she generally must take the first RMD by April 1 of the following calendar year. IRS Publication 590 lists the exceptions and other rule clarifications.

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.

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