Taxing State Disability Insurance

Q: I am receiving state disability insurance and expect to remain on the program for at least two more months this year. Are these benefits included in my taxable income for state and federal income tax purposes? --P.S .

A: Generally speaking, state disability insurance payments are not taxed by either the state or the federal government. There is one exception: When a taxpayer receives disability insurance payments in lieu of unemployment insurance, the federal government will tax the disability payments up to the maximum amount the recipient was eligible to receive in unemployment insurance. However, in this case, the state does not tax the payments because the state does not tax unemployment benefits, either.

Medicare Benefits Usually End at Border

Q: I plan to retire to France next year after spending a lifetime working and contributing to Social Security--here in the United States. Is it really true that I may not use my Medicare benefits while residing abroad? --V.J.C.

A: With only minor exceptions, largely involving extraordinary events occurring in the neighboring countries of Mexico and Canada, Medicare treatment is not available outside the United States. However, taxpayers who are otherwise eligible for full Medicare benefits may receive them upon re-entry into the United States, provided that they have continued to participate in the Part B (medical treatment) portion of the program by paying their monthly premiums.

Perhaps the largest single obstacle to extending Medicare benefits to Americans living abroad, Social Security officials say, is the expected bureaucratic nightmare of administering the program through literally hundreds of foreign medical delivery systems.

By the way, cash Social Security benefits are completely portable and are paid regardless of where the eligible recipient lives. Supplemental Security Income (SSI) benefits, which are administered by the Social Security Administration, terminate at the U.S. border.

How Pension Benefits Affect Social Security

Q: In a recent article, you mentioned that recipients of government pensions are subject to reductions in their Social Security benefits to eliminate potential duplication of payments to retired government workers. Does this provision apply as well to recipients of pensions from private companies where the employer is providing the full pension payment? --J.C .

A: Not at all. Only recipients of government pensions are subject to the so-called “government pension offset” and “windfall elimination” provisions. Recipients of pensions from private enterprise receive their full entitlement of Social Security benefits.

Why? Congress concluded that government employees could unfairly profit from the combination of both a government pension and Social Security benefits originally intended for private-sector employees who worked at relatively low wages throughout their careers.

Remember, the federal government and many other public agencies do not belong to the Social Security system. Many public workers, however, take second jobs or become self-employed long enough to meet the minimum enrollment requirement for Social Security. When it comes time to retire, these workers would be eligible for the Social Security benefits intended for the lower-wage, private-sector employees. This benefit is weighted to give the lower-wage worker a greater return on his contributions than other, more highly paid workers get.

So Congress passed the “windfall elimination” provision to put government employees’ Social Security benefits more in line with what workers in the private sector receive. Although the windfall elimination provision reduces the Social Security benefits of a government pensioned retiree, it does not eliminate them.

401(k) Rollover Rules Apply to 403(b)

Q: Are rollovers from 403(b) plans into individual retirement accounts subject to the same rules that govern transfers from 401(k) plans and IRAs? A.P .

A: Yes, and this means that if you take possession of your 403(b) funds before depositing them into an individual retirement account, you will be subject to 20% withholding for income tax purposes on the payout. Why? Because the government is assuming that you are cashing out of your retirement savings plan and wants its tax payment immediately. Further, if you are under age 59 1/2 and redeposit your account proceeds within 60 days into an IRA, you will be forced to dig into your pocket to come up with the 20% that the government withheld or face an early withdrawal penalty of 10% federal and 2.5% California on those funds.

The best way to handle a lump-sum withdrawal move from either a 401(k) or 403(b) plan is through what is known as a “trustee-to-trustee” transfer. This ensures that you will not touch the money and cannot be hit with either the withholding tax or potential penalty.