President’s Tax Plan Will Hit Middle-Income Retirees

If you believe that rich folks are going to be hit with the biggest tax increases in President Clinton’s tax plan, you probably haven’t talked to Howard Haglund.

The Laguna Niguel retiree says he and his wife are getting socked with a 13% tax hike--amounting to $1,243--because their pension and investment income amounts to roughly $58,000.

“People who have three times the income we’ve got are facing a 5% increase,” Haglund complains. “We’re not rich, but our actual tax is 13% higher than it was before.”

Haglund is not alone. Millions of middle-income retirees are going to get hit with double-digit tax hikes, thanks to the plan, accountants say. What’s worse is that--unlike the rich--retirees have very few ways to avoid the tax.

“It is tough to get out of this if you have Social Security income and a significant amount of investment income from any source,” says Philip J. Holthouse, partner at Holthouse Carlin & Van Trigt in West Los Angeles. “One way or another, you’re going to get nicked.”

Retirees get hit because Clinton’s tax package makes more of their Social Security income taxable if they earn more than $34,000 individually or $44,000 as a couple. Once you pass these thresholds, 85% of your Social Security income is taxable versus 50% for those earning less. Social Security income isn’t taxable at all for those who earn less than $25,000 individually or $32,000 as a couple.

The bottom line: While the rich are likely to pay more in dollars and cents, no one will face bigger percentage increases from the newly passed law than Social Security recipients who have comfortable incomes.

Consider a single retiree with $36,000 in income, including $8,000 in Social Security benefits. Under the old law, $4,000 of his Social Security benefits were taxable at a 28% rate. That amounted to $1,120 in tax. Under the new law, $5,700 of his benefits are taxable, which boosts the Social Security tax to $1,596--a 42.5% hike.

Worse still, many of the tax-deferral gambits that can be used by wealthy taxpayers don’t help old folks. Here’s why:

* You can’t contribute to a tax-deferred retirement plan unless you’ve got earned income, as opposed to pension and investment income--and few Social Security recipients do.

* You probably can’t shift money to your children and benefit from their lower tax rates, because, at this age, your children are probably in the same--or a higher--tax bracket than you.

* You don’t get any real benefit from investing in municipal bonds because, in a back-ended way, you get taxed on the interest. The way this works is Byzantine, but here’s the thumbnail sketch: No matter what your age, municipal bond income is not federally taxable. But, when you’re trying to figure out how much of your Social Security benefits are taxable, you have to add municipal bond income into your adjusted gross income.

If your total “modified adjusted gross income”--that’s taxable income plus normally non-taxable interest earnings--adds to more than the threshold amount, it makes a portion of your Social Security income taxable.

* You can contribute to charity to lower your overall taxable income. But these contributions--part of your itemized deductions--come after the Social Security calculation, so they don’t affect the determination of how much of your Social Security income is taxable.

Additionally, some maintain, people at these income levels have limited ability to participate in tax planning strategies under any circumstances. Indeed, tax experts say, the options boil down to a few that may be unattractive or impractical for many retirees.

“I have never known anyone earning $34,000 or $44,000 who thought of themselves as wealthy,” says David Berenson, managing partner at the accounting firm of Berenson & Co. in New York.

Essentially, all retirees can do is shift assets out of interest and dividend-earning investments to investments that appreciate but don’t generate current income.

This type of investment would include many growth stocks and growth stock mutual funds. It also includes savings bonds but does not include most other types of zero coupon bonds, says Holthouse. That’s because savings bonds have a special status that allows investors to recognize their increased value only at the time of sale or maturity. Investors have to recognize the rising value of other types of zero coupon bonds annually.

However, those who need income from their investments to maintain their current lifestyles will simply have to pay more tax.