Tax Break on Retirement Income Benefits Retirees Who Move to Another State

Q If I move from California to another state, how do I transfer an IRA? Are there any immediate tax consequences, and will I have to pay any California state taxes when I withdraw the funds at a later date?

--C.R.

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A. Any taxpayer may transfer funds from one invidual retirement account trustee to another, regardless of the location of the trustees. Simply ask the trustee of your current account to assist you in the transfer.

You may elect to take the funds yourself, in the form of a check, and redeposit them yourself in a new IRA in your new community. Or you may request a trustee-to-trustee transfer that essentially keeps you out of the process. If you elect to get involved directly, be aware that you have 60 days in which to complete the transfer. If you hold onto the funds for longer, it can be considered a taxable withdrawal, and depending on your age, you could be subject to a premature-withdrawal penalty.

As of the 1996 tax year, and thanks to a new federal law, pensions and other retirement income, including IRA withdrawals, are no longer subject to taxes by the state in which the funds were earned or accumulated.

What does this mean? It means you are required to pay state taxes on your pensions and other retirement income only to the state in which you reside. Taxpayers who move from states with income taxes to states with no income taxes can escape state taxes entirely.

This is an especially welcome development for retirees who used to live in California or who want to move out of the state, because California tax officials had been particularly aggressive in asserting their right to tax income accumulated or earned during the time former California residents lived in the state.

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Q. I’ve just spent hours figuring out how much I have to save for retirement, and now I hear that my retirement age won’t be 65! I’m 37.

--K.J.

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A. That’s right. For the great majority of working people today, the standard age for getting full Social Security retirement benefits will not be 65. In your case, it will be 67.

If you turn 60 years old in 1998, you are a member of the first group to have to wait a little longer--two months after you hit 65.

According to the new rules, the age rises slowly to a plateau, so that everyone who turns 44 to 55 years old in 1998 will be eligible at age 66. Then the age rises slowly again until anyone 41 or younger this year will have a retirement age of 67.

Early retirement under Social Security is still available, at reduced benefits, and you can still increase your monthly benefits if you start Social Security later, up to age 70.

Given all the talk in Washington about “saving” Social Security, there is the possibility that some of these numbers could change, especially for younger people.

In the meantime, along with inflation adjustments for payments to current recipients, the amount of earnings subject to the FICA tax rate of 6.2% will increase this year to $68,400 from $65,400 in 1997. The 1.45% Medicare insurance tax applies to all earnings.

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Q. I have retired and will soon turn 54. I would like to begin taking distributions from my IRA in a fashion that will not expose me to any penalty.

What may I do? Can I just pick the amount I need to live on and take that amount for five years? I think that’s what a friend told me.

--G.S.R.

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A. Able-bodied taxpayers under age 59 1/2 may withdraw funds from their IRAs without penalty if the disbursements are made under one of three “substantially equal” annuity-type formulas approved by the Internal Revenue Service.

Taxpayers taking early withdrawals must take the disbursements at the rate determined by the formula of their choosing, and for either five years or until reaching age 59 1/2, whichever occurs later. The withdrawal formula cannot change until the minimum period has been completed.

You may not simply select an amount of your choosing; one of the formulas approved by the IRS must be used. Failure to precisely follow the formula of your choice will expose you to the 10% federal and 2.5% state of California penalties for early withdrawal.

By the way, even though you may avoid penalty for your early withdrawals, the funds will still be subject to income taxes, as they would had you waited until the traditional age of 59 1/2 to begin distributions.

For more information about the three formulas, see IRS Publications 939 and 590. Call (800) 829-3676 to order.

Carla Lazzareschi cannot answer mail individually but will respond in this column to financial questions of general interest. Write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail [email protected]