Feb

9

Taxes and Social Security

Posted by cameron

February 9, 2007 |

Many people seem to think that Social Security pensions and even IRA withdrawals are not taxable. This is not true. Get that clear in your minds. Any government that is willing to tax unemployment benefits will surely not miss out on the opportunity to nail your Social Security check. This post is purely about the Social Security check and how much is visible to the tax man. There is a line on the 1040 where you enter the amount of the Social Security check that is taxable. That amount will then be added to your other taxable incomes to figure out your overall tax liability. Clearly it would be a good thing for that Social Security number to be zero.

The IRS always makes their publications complicated. There are so many pages you must wade through to get to that one nugget of information you are looking for. Since it is a government publication you may not even recognize it when you see it. Following is the short, easy to understand version of “the rules” that I use:

Is any part of your Social Security check taxable? Add ½ your Social Security annual income to all your other incomes and compare that to something the IRS calls the base number. For a married couple filing jointly the base number is $32k. For a single person it is $25k. If that income number is less than those base numbers then your social security check will not be taxed. In the overall picture of retirement taxes this is really important because it allows you to put a “0” on your tax form for Social Security income. This means your 1040 will only show your other incomes and you still have your standard or itemized deductions to hide behind. If that income number is above your particular base number then some portion of your Social Security check will be taxable.

If so, how much is taxable? When the income number, calculated above, is higher than that base number, then you are in jeopardy of paying taxes on some portion of your social security check. Now the question becomes how much is taxable? The IRS has a bunch of complicated rules which shake out to mean the following:

  • Determine the taxable portion by subtracting that income number above from the base number that applies to you. This is the portion that is in jeopardy. Notice that the calculations are only using half the social security income to calculate this, which means that the maximum that is taxable is 50% unless your income exceeds another key number, which you must know.
  • If your income plus ½ Social Security amount is $44K or higher for a married couple filing jointly or $34K for a single then you could pay taxes of 85% of a part of your Social Security check. There are some special rules applied to people still paying into an IRA but it will be better for understanding to ignore that for the moment. So married people have two important boundary conditions to remember: $32K and $44K.
  • Basically it comes down to this: below 32K SS is not taxable. Between 32K and 44K 50% of a portion is taxable and above 44K 85% of a portion is taxable. The total taxable is the sum of the two pieces.

Examples:

Married Couple Example. Say the combined annual Social Security income is $20k and the total of all other income is $10k then no part of the social security check is taxable because ½ SS plus income = $20k. That is below the 32k boundary.

Married Couple Example. Say the combined annual Social Security income is $20k and the total of all other income is $30k. 1/2SS plus income = $40k. This is above the $32k boundary, yet below the $44k boundary and $5k of the pension will be taxable income. That is a portion of the amount over $32k

Married Couple Example. Say the combined annual Social Security income is $30k and the total of all other income is $40k. Obviously the $32k boundary is breached and so is the $44k boundary, so we know that the 85% rule is now in play. This calculates out to $15,350 of the pension that is taxable.

What to do with this information

I realized how important it was to understand these rules when I laid them into my Retirement Income Plan spreadsheet. You can see my 3 Steps to Retirement Income Planning here. The next step is to plug the rules into your spreadsheet along with the regular tax rules on income so you can figure out how much money you will have. You can also study the details in IRS Publication 915 where the IRS has some example worksheets. The neat thing about going with a spreadsheet is that when you change one condition or number you can watch the results ripple right through the entire retirement plan. “What if” scenarios are easily played, as are tax changes.


Comments

2 Comments so far

  1. IRS Retirement Forms and Worksheets · Empty Nest on March 18, 2007 7:15 am

    […] To see previous posts on these topics go here, here and here. (This is worthwhile reading.) Share and Enjoy:These icons link to social bookmarking sites where readers can share and discover new web pages. […]

  2. Social Security Tax Trap :: Empty Nest on May 22, 2007 6:02 am

    […] So you get your new statement from Social Security and it projected an increase of approximately 3% this year and 4 % last year. You think you are doing well. Think again. You are slowly but surely sliding into the Social Security Tax Trap. The Social Security payment increases each year when the government takes a snapshot of the countries inflation rate. It uses that to determine the following years increase in Social Security payments. Unfortunately the government doesn’t apply it to the income tax limits before taxes apply. As you will see from the example below, this has the affect of moving you, year after year, into a more heavily taxed situation. In fact, given enough time, every single person in the States will end up paying taxes on most of their Social Security check. If you live long enough they will break you financially. If you haven’t read the post about taxes on social security you can look here. […]

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