Everyone should know by now that if you started contributing to the Public Safety Personnel Retirement System (PSPRS) before July of 2011 you will soon be receiving a refund for any of your contributions that exceeded 7.65% of your paycheck. How exactly that refund is given to you is still to be determined.
One answer is that the possibility may exist for you to roll it into your retirement account (457), or to roll part of it. A simple example would be if your refund is $12,000 and you roll all of it into your retirement account than you pay no tax on the refund in this year.
On the other hand if you get the refund in a check that you can spend however you wish then it will be taxed as income. It won’t be taxed at a different tax rate than the rest of your income.
A basic example is if your normal taxable income is $50,000 and you are getting a refund of $12,000 then you will have a taxable income of $62,000.
People are concerned about this because we don’t know, how much tax will come out of the refund. This confuses people who don’t understand taxes versus tax withholding.
Keep in mind the amount of money that comes out of your paycheck is only an estimate of how much tax you may owe at the end of the year. The same is true of the refund.
At the end of the year you do your taxes and calculate how much tax you owe. Then, if for example you calculate that you owe $8,000 and you had $12,000 taken out of your paycheck throughout the year you would get a refund of $4,000.
If on the other hand you calculate that you owe $14,000 then you would have to pay $2,000, since you only gave them $12,000.
Why does this matter? Because a lot of rumors has been swirling that the refund may be “taxed” at 25% or 40% or some other random percentage. First off, we don’t know what percentage it will be withheld at until a decision is made so stop worrying about it.
Second, remember this has nothing to do with how much it is taxed. This is only how much of the refund will go to the government until you calculate your taxes at the end of the year. If too much of the refund went to the government then you will get back what you are owed in your tax refund. Likewise, if not enough went to the government then you will owe the difference.
The bottom line is not to stress over how much is taken out of your refund for taxes. You will settle up with the government at the end of the year.
I will be posting a follow up to this which explains some tax basics. A lot of people need to understand how much influence you have on how much tax you pay. It doesn’t take much to understand how to save from paying the government too much. I hate paying taxes like everyone else, so take some steps to pay them less.