Dear Mr. Pease:
Many thanks for your insightful column on the marginal tax rates on tax-deferred investments. A few years ago (just after Bill Clinton's biggest-ever-in-history tax increase), I suffered a similar tax-torture when I withdrew some money from a tax-deferred account before the age of eligibility. I needed the money fast, because I had a chance to buy a small summer cottage at an attractive price—but only if I could come up with the money down within a few days. It was just another investment, really. At the end of the year, I chugged through the tax calculations for the "with withdrawal" and "without withdrawal" cases and discovered (much to my shock and horror) that my marginal rate (Federal, State, and penalties) on the withdrawal was over 60%! (At the time, I was living in a high-tax northeastern state.)
ANY other way to finance my purchase would have saved me a lot of money. What I should have done is taken some kind of personal loan, made the purchase, and then later refinanced the cottage with a 90% mortgage. This would have actually DECREASED my taxes! Instead, I was absolutely hammered.
So it turns out that the tax-deferred investment is a sham for most people, no matter how you look at it. If you ever need to withdraw money BEFORE eligibility you get slammed, and if you withdraw money AFTER you are receiving Social Security you get slammed again because it reduces your benefits. I guess there is a brief window between 55 and Social Security in which you can withdraw money and pay only your "normal" marginal rate, whatever that may be.
Which brings me to the real point in all of this. People talk a great deal about the long-term funding problems of Social Security. The whole argument gets bogged down in the discussion of whether Social Security should be funded only by FICA taxes or out of "general revenues," and whether Social Security benefits should be taxed or not, and at what rate.
I don't know about you, but when the money's gone from my bank account, I don't really give a hoot where the government says it went. It's gone, and I know it's not coming back. People who work hard, make some money, save, and invest (over a lifetime) can be pretty sure they are never going to see much from the payments they made to Social Security. Meanwhile, the people who didn't accomplish much and never saved a dime can be pretty sure they will receive 50 times what they "contributed."
I wish all the politicians and pundits would play it straight on Social Security and call it what it is: welfare for poor people over 65. If we could all acknowledge that Social Security is just welfare for older citizens, then we could make some rational decisions about eligibility and funding. As things stand, most people don't understand what Social Security is, nor how it works. So rational discourse about funding and eligibility is just about impossible. Please keep poking holes in the nonsense!
STEVE FITZPATRICK
via e-mail
Steve, thanks for reminding us about the penalties for early withdrawal. That's one more place you can get hurt if you don't understand the rules BEFORE you start playing. Other people have similar comments. Short-term capital-gains taxes are much heavier than long term. You have a chance only if you plan ahead and learn the rules.—RAP
All for now. / Comments invited!
RAP / Robert A. Pease / Engineer
rap@galaxy.nsc.com.—or:
Address:
Mail Stop D2597A
National Semiconductor
P.O. Box 58090
Santa Clara, CA 95052-8090