This is the third and final article of a three-part series to help married couples maximize the total amount of Social Security benefits they will receive in their lifetimes.
How Social Security Benefits Are Taxed
The amount that benefits are taxed is determined by how much other earned income a person has. In this case, earned income includes income from pensions, investments, tax-free income from municipal bonds and, of course, any income from a job. The number to be concerned with is called “provisional income.” Provisional income is adjusted gross income (AGI) plus one half of an individual’s Social Security benefits plus tax-exempt interest. Here’s the breakdown on how benefits are taxed:
|Filing Status||Provisional Income||Amount of SS Subject to Tax|
|Married filing jointly||
$32,000 – $44,000
|Single, head of household, qualified widow(er), married filing separately and living apart from spouse||Under $25,000$25,000 – $34,000Over $34,000||
|Married filing separately and living with spouse||Over $0||85%|
How to Keep Uncle Sam Away From Social Security Benefits
An interesting fact about the numbers in the above chart is that they were set in 1983 and are not adjusted for inflation. As Social Security benefits and earned income continue to increase, people have a harder time finding ways to keep their Social Security benefits from being taxable. The issue of taxes calls for some thoughtful Social Security benefits planning.
The first part of planning involves looking at the thresholds for provisional income. For a demonstration of how this works, first consider a married couple filing their taxes jointly. They decide to look at how much extra income they can earn and still be under the 50% threshold. They would take $32,000 and subtract half of their total social security income from it. So if they are collecting total benefits of $35,000 a year, they would do the following calculation: $32,000 – $17,500 = $14,500. This means they could earn $14,500 in other income and remain under the 50% threshold. Their total income would be the $14,500 other income plus their total Social Security benefits of $35,000 for a total income of $49,500 or $4,125 a month. That’s not too shabby. If they needed more income than that, they would have to look at trying to stay under the 85% threshold.
The Ticking RMD Tax Bomb
An individual getting close to retirement most likely has retirement dollars in qualified plans such as 401k’s and IRA’s. These dollars have been allowed to grow tax-deferred for a very long time. But guess what? The government isn’t going to allow someone to keep that money in an account that grows tax-deferred forever. That’s why they came up with a calculation called Required Minimum Distributions. This is the minimum amount of dollars an individual has to take out of qualified plans, such as 401k’s and IRA’s, starting on April 1st of the year following their 70 ½ birthday, or the year they retire. The distribution has to be taken by December 31st of every calendar year.
How do RMD’s affect Social Security benefits? RMD’s count as earned income for tax purposes. Anything taken out of a 401k and/or IRA will add to provisional income and potentially cause a higher portion of Social Security benefits to be taxable.
From an earlier example, pretend there is a married couple; each person is 70 years old. Assume that they are receiving $45,000 a year in Social Security benefits and they’re trying to stay under the 50% threshold. They would take half of their Social Security benefits ($22,500) and subtract it from $32,000. This means they can earn additional income of $9,500 and still remain under the 50% threshold. Since they’re both 70 years old they would have to take RMD’s very soon. They would take $9,500 and multiply it by 27.4 which is the applicable withdrawal factor for RMD’s for a person age 70. A copy of the table can be found here. This calculation tells them that they can have $260,300 in an IRA at that time and their RMD will not bump them above the 50% threshold. If they have more than $260,300 in IRA or 401k dollars then they risk going above the 50% threshold. Check out this RMD calculator from FINRA.org to assist in benefits planning.
The Two Certainties of Life – Death and Taxes
Yes, death and taxes are a bummer to think about. The good news is that with a little bit of thoughtful planning before and during retirement a person can lessen the effects taxes will have on their overall income and wealth. They can also ensure that their loved ones will be well taken care of and will be thankful they had someone that cared enough about them to put some time into their planning before it was too late.
Neither Woodbury Financial Services, Inc. nor its representatives offer tax or legal advice. For assistance with these matters, please consult your tax or legal advisor. While this information has been checked with sources believed to be reliable, the accuracy cannot be guaranteed. This information is intended for general education only, and investors should carefully consider their personal situation and circumstances. Securities and Investment Advisory Services offered through Woodbury Financial Services, Inc. Member FINRA, SIPC and Registered Investment Adviser. PO Box 64284 St. Paul, MN 55164 (800)800-2638.