Although few middle-income workers realize it, Washington has been steadily chipping away at retirement tax breaks, according to a new study from the Center for Economic Policy Research at Stanford. In their zeal to make sure millionaires don't get away with anything much, the study argues, Washington has created "tax traps" for the middle-income thrifty who invest well.

Although Congress this year suspended for three years a 15 percent tax on "excess distributions" from retirement savings plans, that window will expire after 1999.

• Taxes on "qualified" retirement savings plans (corporate pension plans, 401(k)s, individual retirement accounts and Keoghs) are deferred until the principal and interest are spent during retirement.

• However, Congress imposed, then temporarily suspended, an extra 15 percent tax on annual distributions exceeding $150,000.

• After 1999, "excess distributions" will be indexed to inflation before they are taxed.

• A companion "excessive accumulation" tax -- not suspended or indexed -- adds a 15 percent surcharge to federal estate taxes on retirement assets in excess of the amount actuarily needed to finance a $155,000 annual pension.

For the estate of a 65-year-old, an accumulation greater than $1.2 million is considered excessive; for an 80-year-old, the figure is about $800,000.

The excess distributions tax is not deductible from state or local income taxes, and personal income taxes must also be paid on tax-sheltered retirement accumulations in estates.

So in some cases involving a $10 million estate, the government would get 99.73 cents out of the last dollar paid to heirs.

A baby-boomer who started work at $15,000 a year in 1971, received modest pay increases until retirement, saved 10 percent of his income and earned 8 percent on it annually, would have accumulated around $2.4 million by age 65. Such a person -- of modest income which was diligently saved -- would be greatly penalized by "excess distributions" and "excess accumulations" tax laws.

According to one of the study's authors congressional action has demonstrated the law of unintended consequences: "I don't think Congress meant to punish those who saved long and successfully with 90 percent taxes," he said.

Source: Peter Passell, "Be Thrifty and Invest Well, and then Wait for the Huge Tax Bill," New York Times, November 21, 1996.