By Joe Elsasser, CFP
Social Security benefits are not subject to federal income tax, but when you combine Social Security benefits with other retirement income, your total income may fall over the threshold. According to the Social Security Administration, roughly 56 percent of eligible people will owe federal income taxes on their benefits. How do you begin by calculating your protracted income?
Half of your Social Security benefits are covered, as well as other taxable income such as dividends, realized interest, and realized capital gains. All non-taxable interest earnings like municipal bonds should be included.
You may have to pay income tax on up to 50% of your benefits if your actual income is $34,000, and youre filing as an individual, up to 85% of your benefits may be taxable.
If youre married and filing jointly, you may have to pay income tax on up to 50% of your benefits if your actual income falls between $32,000 and $44,000. Up to 85% of your benefits may be taxable if your combined income exceeds the $44,000 threshold.
Then subtract the first threshold and multiply by.5. Add up the results. If the total amount is less than the maximum, that is the taxable amount. If the total amount is greater than the maximum, the taxable amount is the max.
Many people believe that exceeding the first threshold automatically makes a full half of their Social Security benefit taxable. This is not the case, but only 50% of the amount over the threshold becomes taxable.
Here''s an example:
A married couple is putting taxes together. They have $40,000 in Social Security benefits and $30,000 in IRA withdrawals. We take half of their Social Security benefits ($20,000) and add it to the $30,000 of IRA withdrawals. They have $50,000 of pro-active income.
We then subtract $32,000 since this is the first threshold for married couples, and multiply by.5. This gives us $9,000. Next, take the temporary income ($50,000) and subtract the second threshold for married couples ($44,000) and multiple by.35, which equals $2,100. Add the $9,000 and the $2,100 for a total of $11,000 in taxable benefits.
Social Security has a significant tax-advantage when it comes to welfare benefits. At worst, 85% of benefits are taxable and 15% are tax-free.
Understanding your own retirement income streams and how they interact is critical. Middle-income retirees may develop tax-efficient retirement strategies by making conscious decisions about which accounts to withdraw from at different points in retirement, including Social Security. A good financial advisor can assist you determine how much of your benefit might be taxable and guide you on which account to use and when to help you achieve your retirement goals.
About the author: Joe Elsasser, CFP
Covisum, a financial technology business that focuses on developing software solutions, practice management, and marketing resources to assist financial advisors and financial institutions thrive and improve their lives through improved retirement decisions. Covisum provides assistance to mass-affluent clients in or near retirement and has oversaw several of the world''s largest financial planning offices.