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FAMILY FINANCE: Retirees eligible for rebate

Lynn Brenner | Family Finance

March 23, 2008

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You must file a 2007 tax return to receive the $600 per individual and $300 per child payments of the "stimulus package." How about retirees and those who do not have to file a tax return? How can they get this money? What kind of tax return must they file?

C.C., New York City

To get a stimulus package rebate check, you must file a tax return that shows at least $3,000 of 2007 earned income. People who are not ordinarily required to file a tax return should use Form 1040 or Form 1040A, just like everyone else.

Retirees can report their Social Security income on line 20a of Form 1040, or on line 14a of Form 1040A. Filing the tax return won't make their Social Security benefits taxable, says Bob Scharin, senior tax analyst at RIA, a division of Thomson Tax and Accounting in Manhattan. They're just filing the return to get the rebate.

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The IRS will look at your 2007 tax return, and if you qualify for a rebate, it will calculate the appropriate amount and mail you a check. Eligible taxpayers will get up to $600 per individual, plus $300 for each qualifying dependent child. You're ineligible if you're an individual taxpayer who makes more than $87,000 or married filing jointly and make more than $174,000.

If you get a check for less than the $600 full payment, you'll have an opportunity to claim the balance of the rebate in 2008 by filling out a worksheet when you file your 2008 tax return. "If you're entitled to extra money, you'll receive it," Scharin says.

Is it true that withdrawals from tax-deferred savings such as IRAs or 401(k)s are taxed as current income? I have been contributing to my IRA for years. The money has mostly been invested in equity mutual funds. These yearly investments came from untaxed earned income, so it makes sense that the principal will be taxed as income when I withdraw it. What about the capital gains? Will I be able to benefit from the 15 percent maximum tax rate on capital gains when I reach 59 1/2?

T.R., via e-mail

Unfortunately, no. Capital gains tax rates don't apply to money withdrawn from tax-deferred retirement accounts like IRAs, 401(k)s, 403(b)s and 457 plans.

All withdrawals from these accounts - both the principal and the earnings - are taxed as ordinary income. (Of course, your ordinary income tax bracket may be lower after you've retired than it was while you were working.)

This tax treatment is the reason some investment professionals advise keeping part of your retirement savings in a taxable account invested in stocks. True, you don't get a tax deduction for money you deposit in this investment as you do with an IRA or a 401(k). But your earnings won't be taxed until you sell the stocks - and then, your profit is taxed at a low capital gains rate. (And of course your original investment - in tax jargon, "your cost basis" - isn't taxed when you sell the stocks because you've already paid taxes on it.)

It's a little harder to do this with a stock mutual fund. When you own individual stocks, you decide when to sell them and incur a tax bill. By contrast, the fund manager decides when to sell the fund's investments - and its taxable gains are passed along to its shareholders. But you can achieve the same goal by investing in a taxable stock fund that has very low turnover - i.e., one that buys and holds stocks for a long time. Such funds include "tax-managed" funds and broadly diversified stock index funds.

Send questions to Family Finance, Business Desk, Newsday, 235 Pinelawn Rd., Melville, NY 11747-4250, or e-mail to Bfamfin@aol.com. Include your age, income and a list of major assets. Letters and e-mails can't be answered personally.