Deferred Comp Federal Tax

[STEVEKEYS]

I'm not ER'd yet, but hopefully will be in about 3 years. I have a deferred comp account at work (457) that is funded with pre-tax gross $ and was doing a little playing in 2006 tax software to see how much in tax I would pay based on withdrawing a given $ amount when ER'd from the 457. I'm able to take any amount of money I want out of my 457 at any age, as long as I'm separated from service, without penalty....good deal!!! In this case, I placed $25,000 as the amount I received on "my 1099R" in the tax software. After entering this $25,000 into the tax software (TaxCut), and not having any fed/state taxes withheld, it says I owe only $813 in federal taxes and $50 in CA state taxes. This is assuming no other income. Now, if I modify the scenario to have $25,000 from income from a j*b, ie a W-2, and remove the 457 income completely from the software, I owe over $3,000 in federal taxes alone. Both cases, I'm using the standard married deduction. Why is the 457 deferred comp income taxed so much lower? I thought it was treated like ordinary income and should be taxed the same as earning from a j*b (ie the W-2)? Is there some kind of break on the tax from 457 deferred comp income that I'm not aware of?

 

[MasterBlaster]

Does your tax software also compute the payroll taxes like Social Security and Medicare plus the California SDI insurance.

SS and Medicare for an employee (not self employed) would be around $2k alone on the $25k amount. You'll have to work out the rest.

 

[MasterBlaster]

OK - for a $25k employee I get

SS and Medicare taxes at $1912.50
Ca OASDI at ~ $147
federal Income taxes of $813 (this is the number you calculated)
California Income Taxes of $50 (this is the number you calculated)

Total tax ~ $2922.50

Its worth noting that if you were self employed the SS and medicare taxes would double. But then half of that new total would be deductable from your income tax.

- Death and taxes !

 

[STEVEKEYS]

Does your tax software also compute the payroll taxes like Social Security and Medicare plus the California SDI insurance.

SS and Medicare for an employee (not self employed) would be around $2k alone on the $25k amount. You'll have to work out the rest.

On the issue of 457 withdrawal taxes: Since I already paid medicare and SS tax on the money I put into the 457, as I understand, why would I need to pay it again when it comes time to withdraw it? All that was deferred from my pay into the 457 was state and fed taxes.

 

[Brat]

Seek the advise of a CPA with experiance in your situation.

My DD is a Controller with a VC, this is a potentially complicated tax issue. Spend a dollar.

 

[maddythebeagle]

On the issue of 457 withdrawal taxes: Since I already paid medicare and SS tax on the money I put into the 457, as I understand, why would I need to pay it again when it comes time to withdraw it? All that was deferred from my pay into the 457 was state and fed taxes.

....I think masterblaster explained it...but here it is again...you pay deferred state and federal taxes on the deferred comp. when you take it out (yes, you already paid medicare and ss) on this money.

 

[MasterBlaster]

Well to beat this thing to death and (hopefully) make it a bit more clear.

You will always pay payroll taxes on earned income (as in income from a job). You won't pay payroll taxes when you take the money out of your 457 plan or an IRA or a 401k plan.

So just to be clear....

If you have a job and earn $25k and have no other income and don't withdraw any 457 money, then your total tax bill including payroll taxes and income taxes will be just shy of $3k as was shown above.

If you have no other income and take $25k out of your deferred comp 457 plan then you will only owe income taxes. Which (per your calculation) were just under $900. Notice that there is no payroll tax (ie, SS and Medicare etc.) due on this money.

The difference is the payroll taxes on earned income versus other income.

 

[MasterBlaster]

Seek the advise of a CPA with experiance in your situation.

My DD is a Controller with a VC, this is a potentially complicated tax issue. Spend a dollar.

I am not sure that I agree with your advice. This isn't rocket science, it's just some normal taxes that are due and that evrybody pretty much should understand. Do you consult a CPA when you take money out of your IRA or your 401k ? It really isn't that complicated. A 457 plan payout is pretty similar to the IRA or 401k distribution.

However, if you are still confused a tax guy will calculate what you owe for a charge.

 

[STEVEKEYS]

Well to beat this thing to death and (hopefully) make it a bit more clear.

You will always pay payroll taxes on earned income (as in income from a job). You won't pay payroll taxes when you take the money out of your 457 plan or an IRA or a 401k plan.

So just to be clear....

If you have a job and earn $25k and have no other income and don't withdraw any 457 money, then your total tax bill including payroll taxes and income taxes will be just shy of $3k as was shown above.

If you have no other income and take $25k out of your deferred comp 457 plan then you will only owe income taxes. Which (per your calculation) were just under $900. Notice that there is no payroll tax (ie, SS and Medicare etc.) due on this money.

The difference is the payroll taxes on earned income versus other income.

Clear as day....thanks again for your response!