Posts Tagged "IRS"

Explaining Social Security’s Earnings Test

The reduction in benefits for some people who collect Social Security while simultaneously working is frequently called a “tax.”

It is not a tax. Under a Social Security rule known as the Retirement Earnings Test (RET), some benefits are withheld if the worker earns above a certain level – $19,560 in 2022 – and has not yet reached his full retirement age under the program. At that age, the government starts paying the deferred benefits back incrementally.

As older workers plot a path to retirement, they should have a clear understanding of this financial impact. But a new study finds they have a poor grasp of the tradeoff that is the central feature of the RET: a smaller monthly check now, while they’re working, in return for a bigger check later.

Failing to understand this concept has real world consequences. Retirement experts encourage boomers to work as much as possible to improve their finances. But someone who doesn’t understand the RET might decide against working more to prevent a perceived benefit cut.

The researchers experimented with how to improve understanding of the RET by showing some 1,000 older workers numerous graphic representations of the financial impact. The best way to illustrate the study’s main finding – that a bar chart emphasizing the shift in benefits from now to later worked best – is to focus here on two pairs of blue bar graphs.

Some workers saw a simple bar graph (below, left) showing that the individual who fully retired at age 62 would receive a $1,000 monthly benefit for life. A second bar graph (below, right) showed a smaller benefit –  about $750 per month – for someone who started Social Security at 62 while he was still working. At 67, his full retirement age, the benefit jumps to about $1,100 when Social Security starts paying back the withheld amount.A second group of workers also saw the simple bar graph (above, left) of the 62-year-old retirees’ stable $1,000 benefit. But the second bar graph (below) illustrated the shift in benefits for a Social Security recipient who is still working.Learn More

Lifting SALT Deduction Would Help the Rich

California mansionsManhattan residents who itemize their federal tax returns pay an average $102,000 in state and local taxes – more than anywhere else. The second highest tax tabs, nearly $50,000, are in Marin County, the home of musicians and movie stars across the Golden Gate Bridge from San Francisco.

Other enclaves with large bills for property, sales, and income taxes include Falls Church, Virginia, a high-income community outside Washington, D.C., and Teton County, Wyoming, where the super-wealthy buy property on the open range surrounding Yellowstone and Grand Teton National Park.

In 2017, Congress put a $10,000 cap on the amount of state and local taxes – or SALT – that all homeowners could deduct on their federal income tax filings. The proposed reconciliation bill being hashed out in Congress might increase or remove that cap.

The Brookings Institution argued that lifting the cap would “massively favor the rich” at a time U.S. inequality is already at historic levels. There is no shortage of evidence to back that up.

High-income Americans on both coasts and in major cities like Chicago and Dallas would save thousands of dollars from lifting the cap on SALT deductions. In Santa Clara County, home to Silicon Valley, for example, the average high-income taxpayer who itemized reported that they paid nearly $47,000 in state and local taxes in 2018, according to the bipartisan Tax Foundation’s analysis of IRS data.

But due to the current cap, the IRS permitted county residents to deduct only about $9,000 for their SALT taxes. (The number is slightly below the $10,000 cap because some itemizers take smaller deductions if, for example, they are renters and don’t pay property taxes.)

One proposal gaining currency in the House would increase the cap on deductions from $10,000 to $80,000, as an alternative to eliminating it entirely. Garrett Watson, author of the Tax Foundation report, said that either raising the cap or another idea – limiting the cap to the nation’s top earners – would still mainly benefit the top 5 percent.

But, he added, preserving some type of cap, even if it’s more generous, “will be less regressive than eliminating it altogether, because the folks at the very top – the multimillionaires and billionaires – would still face that curtailed SALT deduction.”

The Tax Policy Center, an affiliate of the Urban Institute and Brookings, estimates that repealing the cap on SALT deductions would increase after-tax income for households earning more than $100,000 by between 1 percent and 2 percent. Families with lower earnings would be unaffected. …Learn More

Low-income Spend Tax Credit on Food, Rent

The fate of the recent expansion of the federal child tax credit is uncertain in the ongoing budget negotiations in Congress. What is clear is that poor and low-income families are putting the increased assistance to good use.

Low-income families figureNine out of 10 families earning less than $35,000 are spending the money on one or more essential living expenses, which include food, utilities, housing, clothing or education needs like books and after-school programs, according to an analysis of U.S. Census data by the Center on Budget and Policy Priorities.

The American Rescue Plan passed in March temporarily increased the credit from $2,000 to $3,600 per year per child for kids under age 6 and to $3,000 for older kids and teenagers. In another temporary provision in the legislation, the IRS sends the credit to families every month in the form of a monthly payment.

The child tax credit is also now fully refundable, which means that low-income people are eligible for the full credit even if they pay little or no income taxes. If the budget negotiations make this a permanent feature of the credit, the IRS would extend the federal assistance to 27 million more children in low-income families.

Unfortunately, the center estimates, there are some 4 million children in families with very low incomes that aren’t receiving the monthly payments, either because they didn’t file taxes in 2019 and 2020 or didn’t receive an economic relief check from the federal government. The IRS has created an online tool for parents to sign up and start receiving the credit.

The Center on Budget and Policy Priorities asked the people it surveyed about their specific uses for the monthly cash payments. Six out of 10 families earning under $35,000 said they are spending the money on food. About half are paying their utilities or housing expenses. Even the non-essential expenses seem like good uses for the extra funds, including car payments, childcare, and paying down debt.

Higher-income families also buy necessities with the extra cash. But low-income families struggle more to pay for their basic living expenses, and the center said they are using more of the money from the tax credit to pay for them. …Learn More

The Problem with Low-Income Tax Credits

The federal tax code offers a nifty tax credit to low-income workers who save for retirement. If only it reached more people.

The Saver’s Credit offers what appears on its face to be a strong incentive: the IRS will return up to 50 percent of the amount low-income workers and married couples put into a retirement plan.

But Barbara Wollan, an 18-year volunteer in Iowa with the Volunteer Income Tax Assistance program, or VITA, which provides free tax preparation to low-income workers, said her clients often don’t qualify. The reason: the tax credit is not what the IRS calls “fully refundable.”

For example, a single person earning $19,750 or less is eligible for a tax credit equal to 50 percent of the amount saved – the maximum retirement plan contribution eligible for the credit is $2,000. The credits are either 10 percent or 20 percent for single workers earning between $19,751 and $33,000. (The income limits are higher for households.)

The catch is that the credit is subtracted from the taxes owed, and low-income people usually pay little or no taxes to the IRS after they take the standard deduction given to all taxpayers. If they don’t owe taxes, they don’t get the credit.

“To dream big about helping low-income people save for retirement, we would make it a refundable credit,” said Wollan, an educator with Iowa State University Extension and Outreach, which distributes research information in her state on topics like finance and agriculture.

Congress is considering providing a refundable credit of up to $500 to single and married savers even if they don’t owe anything at tax time. But lawmakers often get into a political disagreement about whether people who don’t pay taxes should get money back from the IRS.

Wollan feels her low-income clients should be rewarded for making what is, for them, a Herculean effort to save. “When I see that they have contributed to a 401(k) or other retirement account, I just want to jump up and down and cheer and pat them on the back,” she said. But “because their income is so low, they don’t get to take advantage of these credits, and that is so sad.” …Learn More

Think of Saver’s Tax Credit as Free Money

Life’s unpleasant surprises – a new set of tires or a big vet bill – can get in the way of saving money for retirement. This is especially true for low-income workers.

But if they are able to save a little here and there, the federal government provides a very big assist through its Saver’s Credit. Unfortunately, low-income workers are also the least likely to be aware the tax credit exists.

Savers credit tableHere’s how the Saver’s Credit works. The IRS returns half of the amount saved over the year – up to certain limits – by a head of household earning less than $29,626 or a couple earning less than $39,501.

So, the head of household with earnings under the income limit who saves $2,000 in a tax-exempt retirement plan like an IRA or an employer 401(k) would get back the IRS’ maximum credit of $1,000. And the couple that saves $4,000 would get back the $2,000 maximum.

Piggy bankGranted, these are very large sums for low-income workers. But if they can manage to save a little bit every week, the Saver’s Credit is effectively free money from the federal government.

Smaller tax credits are available to people with slightly higher incomes. Individuals and couples do not qualify if they earn more than $49,500 and $66,000, respectively.

Unfortunately, only about a third of households earning under $50,000 are aware of the credit, according to a Transamerica Institute survey.

Now that you know, start saving. You’ll get a big chunk of it back. …Learn More

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What the Research Can Tell us about Retiring

It’s difficult to envision what life will look like on the other side of the consequential decision to retire.

But research can help demystify what lies ahead – about the decision itself, the financial challenges, and even the taxes. Readers understand this, as evidenced by the most popular blog posts in the first three months of the year.

Here are the highlights:

The retirement decision. The article, “Retirement Ages Geared to Life Expectancy,” attracted the most reader traffic. Myriad considerations go into a decision to retire. But a sense of whether one might live a long time – because of good health or simply seeing that parents or neighbors are living unusually long – is a compelling reason to postpone retirement either to remain active or to build up one’s finances to fund a longer retirement.

A recent study found that as men’s life spans have increased, they have responded by remaining in the labor force longer, especially in areas of the country with strong job markets and more opportunity. This is also true, though to a lesser extent, for working women.

The planning. The second most popular blog was, “Big Picture Helps with Retirement Finances.” It described the success researchers have had with an online tool they designed, which shows older workers the impact on their retirement income of various decisions. When participants in the experiment selected when to start Social Security or how to withdraw 401(k) funds, the tool estimated their total retirement income. If they changed their minds, the income estimate would change.

The tool isn’t sold commercially. But it’s encouraging that researchers are looking for real-world solutions to the financial planning problem, since the insights from experiments like these often make their way into the online tools that are available to everyone.

The taxes. It’s common for a worker’s income to drop after retiring. So the good news shouldn’t be surprising in a study highlighted in a recent blog, “How Much Will Your Retirement Taxes Be?” Four out of five retired households pay little or no federal and state income taxes, the researchers found. But taxes are an important consideration for retirees who have saved substantial sums. …Learn More

Will More Aid to Parents Be Permanent?

Happy children standing together

To lift families out of poverty during the pandemic, Congress is on the verge of passing a substantial increase this year in the standard child tax credit as part of President Biden’s broader relief package.

But despite the sharp divide over the $1.9 trillion package, some senators – both Democrats and Republicans – want to permanently increase federal assistance to families. Their goals range from reducing racial inequality and rural poverty to providing more financial stability for middle- and working-class parents.

The prospect of a bipartisan plan for increasing assistance to parents beyond this year is welcomed by advocates for the poor and lower-income workers. The proposals represent a belief “that all of society benefits when children are doing well,” said Myra Jones-Taylor, chief policy officer for Zero to Three, which promotes policies to help infants and toddlers.

Prior to COVID-19, she said 40 percent of infants and toddlers were in families below 200 percent of the poverty limit. Parents “didn’t have the financial resources to meet their [children’s] basic needs,” she said.

The current proposal in Congress for immediate pandemic relief would increase the per-child tax credit in 2021 from the current level of $2,000 to $3,600 for children under age 6 and $3,000 for older children and teenagers. This same increase is included in a bill by Democratic Sens. Michael Bennet of Colorado and Sherrod Brown of Ohio to make the larger tax credits permanent.

Republican Sen. Mitt Romney’s plan is even more generous. The Utah senator proposed $4,200 in annual cash payments for children under 6 and $3,000 for older children, and some Republicans may be willing to go along. Romney’s plan, if passed, “would arguably be the biggest anti-poverty measure since the Social Security Act of 1935,” Samuel Hammond, director of poverty and welfare policy at the Niskanen Center, a Washington think tank, said in an interview.

But Hammond said members of both parties are making serious efforts to alleviate poverty by targeting assistance to children. The United States has the highest poverty rate of any developed country, “because we spend so little on child benefits, and the benefits we do have cut out the poorest families,” he said. The current tax credit is not available at all to the unemployed and low-income families earning under $2,500.

Hammond and Jones-Taylor were among the panelists in a webinar last month at the Urban Institute to explore the pros and cons of each approach – a tax credit versus monthly cash assistance. …Learn More