HHS PROPOSES SAFE HARBOR APPROACH FOR COMPUTING TAXABLE PORTION OF FEDERAL RETIREES' ALTERNATIVE TYPE PENSIONS.

During a recent 3-way telephone conversation among your office, our Social Security Administration's operating division retirement counselor (Mary Fields) and myself, we discussed the very favorable impact of the newly announced "safe-harbors" method of calculating taxable and tax-free portions of retirement annuities on retiring Federal employees.

We agreed that the new method will be tremendously helpful to the 20% or so of retiring Federal employees who elect a "regular annuity" under either "CSRS" or "FERS."

We also agreed that -- so far -- the "safe-harbors" approach (in the limited form recently announced) is not helpful for (or applicable to) the approximately 80% of retiring Federal employees who elect the "Alternative Form of Annuity" option (lump-sum refund of life-time employee withholdings prior to calculation of monthly pension) provided for in [sic] original the FERS enabling legislation of 1986.

When we suggested a simple method of extending the "safe- harbors" approach to a lump-sum refund and reduced monthly annuity, we were advised to "put it in writing" and submit it to your office for consideration for possible inclusion in the next IRS "safe- harbors" announcement or in your next reissue of IRS Publication #721.

The enclosure is the result of those efforts.

We strongly urge its inclusion, especially as the addition would have virtually NO IMPACT on Federal income taxes collected:

In the example used in the enclosure, the retiring employee has $40,000 in already tax-paid withholdings to be returned tax-free during his life expectance. This is not a situation where using a different method of calculation might result in $39,000 or $41,000 being tax-free. UNDER ALL OPTIONS the annuitant (or his survivor or his or her estate) will eventually credit the withheld $40,000 -- exactly -- as a tax-free portion of annuities received.

Further, assuming the 28% tax bracket applies to most Federal retirees and will for the foreseeable future, it makes little difference in what year a tax-free portion is claimed -- the same 28% tax rate will apply to the remainder of each monthly annuity in any year.

Since the timeliness of results of various calculations are, therefore, relatively unimportant over the long haul, it should be possible to give paramount importance to offering the taxpayer the "easiest calculation" (simplest for the taxpayer) -- as proposed in the enclosure.

Do you have comments -- on these invited comments?

Sincerely yours,

LIFE EXPECTANCY TABLE - SAFE-HARBORS METHOD

     Age at Retirement             Projected Monthly Payments

Example: Employee A, age 61, has had $40,000 of retirement withholdings over his life-time career with employer X. He is eligible for a pension of $2,000 per month. However, his pension plan allows the option of withdrawing the $40,000 in a lump-sum and receiving reduced monthly payments of $1,800. He also has the option to elect a 50% survivor annuity for his wife in exchange for a 10% reduction in his monthly annuity. The effect of choosing one or both options:

full monthly annuity          $2,000    $2,000    $2,000

** as increased over time by cost of living adjustments

Beginning with the 24lst monthly annuity payment (to either the annuitant or his surviving spouse), the annuity would be fully taxable.

[If death occurs before 240 payments have been received (by the annuitant -- if a full monthly annuity elected, or by both the annuitant and his spouse -- if a survivor annuity was elected), the unrecovered portion is applied by the estate executor to the final year tax return.]

Additional calculations to be used if a lump-sum refund is elected (continuing with the same example):

Divide the tax-free portion of the monthly annunity by the full (originally calculated) monthly annuity:

     (tax-free portion)     $  166.67   =    8.33%

** as increased over time by cost of living adjustments

Beginning with the 24lst monthly annuity payment (to either the annuitant or his surviving spouse) the annuity would be fully taxable.

[If death occurs before 240 payments have been received (by the annuitant -- if a retiree-only monthly annuity elected, or by both the retiree and his spouse -- if a survivor annuity was elected), the unrecovered portion is applied by the estate executor to the final year tax return.]

[END of proposed addition]