Social Security as Taxable Income

There are many misconceptions about taxes and social security benefits. A common one concerns how much of the benefit will be lost to taxes.

Generally, social security benefits are taxable only if you earned income, such as from wages or investments after retirement, in addition to your benefits. Understanding when tax is triggered can help reduce the tax burden.

How Social Security Tax Is Determined

No more than 85 percent of your social security benefit is added to taxable income—and probably less. Actual tax is determined by modified adjusted gross income (MAGI) and marginal tax rate, which can range from 10 percent to 37 percent of taxable income—or more, if your state taxes social security benefits.

Calculating MAGI. To find out whether your benefits are taxable, calculate your MAGI. For you and your spouse, add the following:

1. 50 percent of social security retirement benefits
2. All income, including tax-exempt interest
3. The amount you come up with is your MAGI

Even if your spouse doesn’t receive benefits, you must add your spouse’s income to yours in order to determine whether your social security benefits are taxable.

Undistributed gain for a tax-deferred annuity is not included in the calculation, nor are distributions from a Roth IRA that has existed for five or more years if you are older than 59½.

Base amount. Once you have calculated your MAGI, compare it with the base amount, which is the maximum combined income you can earn or receive before social security benefits are taxable.

Your base amount is:

- - $25,000 if you are single, head of household, or qualifying widow(er)
  - $25,000 if you are married filing separately and lived apart from your spouse for the entire tax year
  - $32,000 if you are married filing jointly
  - $0 if you are married filing separately and lived with your spouse at any time during the tax year

If your MAGI is greater than the base amount, your social security benefit is taxable. For most retirees, up to 50 percent of benefits are taxable. Up to 85 percent of benefits can be taxable if one of the following situations applies:

- - The total of one-half of benefits and all other income is more than $34,000 ($44,000 if an individual is married filing jointly).
  - You are married filing separately and lived with your spouse at any time during the tax year.

IRS Publication 915 provides detailed information, with examples and worksheets, to help you calculate the tax impact on social security benefits.

Strategies to Help Minimize Taxes

The key to minimizing taxes on social security retirement benefits is reducing MAGI. If you or your spouse still earns wages and cash flow is not an issue, consider delaying your application for social security until your taxable income is lower. Delaying receipt of benefits can increase future benefits by as much as 8 percent per year. In addition, a delay can increase the protection for a surviving spouse.

Another strategy for reducing MAGI is investing a portion of your portfolio in a nonqualified tax-deferred annuity. With a deferred annuity, only the increase in the value withdrawn is currently considered taxable and added to the MAGI calculation. Please note: This can be a double-edged sword. When a distribution is taken from an annuity, earnings are taxed at higher ordinary income tax rates, rather than at capital gains rates. Also, beneficiaries don’t receive an increase in tax basis at the annuitant’s death for inherited annuities.

Another approach that may reduce your tax obligation is to draw down a Roth IRA before touching an employer-provided retirement plan or other type of IRA. Qualified Roth distributions are tax free and do not enter into the MAGI calculation. But bear in mind that, to qualify, you must be 59½ or older when the distribution is taken and the Roth distribution must be withdrawn from an account that has existed for at least five years.

Your Retirement Portfolio

To minimize taxes on your social security retirement benefits, it is important to coordinate your other retirement income and possible tax deductions. But taxes are not the only factor to consider when making investment choices for your retirement portfolio—and there are no hard and fast rules. We can help you evaluate your individual circumstances and provide the tools and information you need to make important decisions about your future.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

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Tom Kennedy is a financial advisor located at Global Wealth Advisors 520 Post Oak., Suite 450, Houston, TX 77027. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial network®, Member FINRA / SIPC, a Registered Investment Adviser. Financial planning services offered through Global Wealth Advisors are separate and unrelated to Commonwealth. He can be reached at (832) 649-8111 or at info@gwadvisors.net.

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