Here is an excerpt out of my book on retirement income:
Social Security was signed into law in 1935 by President Franklyn D. Roosevelt. When he signed this bill he stated that in no way will Social Security be taxed. We know of two things that happened since: President Roosevelt died and Congress decided to tax social security. In 1983 Congress added another amendment to tax Social Security. Here is how it works.
How would this apply to you and your social security? A single taxpayer making over $25,000 a year and a married couple filing jointly making over $32,000 a year will be taxed up to half of their Social Security income. So up to 50% of your income will be taxed if you fall in to either of these categories.
A single person making over $34,000 and a married couple filing jointly making over $45,000 will have 85% of their Social Security income taxed. These taxes are significant if you fall into either of these two categories. Taxes could put a large dent into your social security if you don’t do the proper planning to get you into the proper tax bracket.
In my experience most of my clients fall close to this category because, even though they have assets, there are opportunities for them to lower the taxable income and in turn help to keep most of your Social Security.
Filed As Single Married Filing Jointly
Base Amount $25,000 $32,000
Taxes owed on the % of your SS 50% 50%
Additional Amount $34,000 $44,000
Taxes owed on the % of your SS 85% 85%
You don’t have to make over $100,000 to be taxed on your social security and every dollar that you count as income will make a difference and you should know your taxable situation. That is one of the most important issues to utilize an adviser for.
Let’s just say that you have a wonderful CD that is paying you the average rate of 1%. I know, that 1% is a bit high but that is what Bankrate.com says is the average so let’s use that rate for simplicities sake.
The CD has $50,000 so the one year interest is $500. This $500 will be used as income and if you are making $32,000 a year as a couple that $500 interest would throw you over the threshold and half of your social security is now taxable. This little amount is something that you now need to take into consideration.
The same could be true with any interest bearing accounts that are not tax deferred like an IRA or annuity. If you had your money in a Tax Deferred Account (TDA) it would grow tax deferred and you wouldn’t have to worry about jumping into an income bracket where your Social Security will be taxed. You only pay on the money you take as income from the tax deferred account.
I have seen people making as high as 6% in these type of tax deferred accounts. That $50,000 could be making you up to $3000 and wouldn’t affect your tax situation. So repositioning what you are currently doing will help you reduce your taxable income and will not go against the calculation of the taxation of your Social Security.
The only amount of your money that should be in an account like a CD or Money Market Fund is the liquid cash you need in emergencies or to pay your daily expenses. This would be your rainy day money.
Just remember that the money in an interest bearing account that is not tax deferred could be used against your taxable income. You may not be living off of this interest but it is still creating a taxable situation for you that could be avoided.
The Table below is the latest from the Tax Foundation and gives you an idea of what your marginal tax rate is for 2014. The marginal tax rate is the rate you would pay at the highest portion of your income. So if you were a married couple filing jointly and made $90,000 a year you would be in the 25% tax bracket. The amount taxed at 25% is $16,199 ($90,000-$73,801). At this rate 85% of your Social Security will be taxed because it is more than the base of $44,000.
So if your Social Security income is $24,000. Add half of the $24,000 to all of your other income, including tax-exempt interest from investments such as municipal bonds. That would be $12,000. If the total exceeds the $32,000 for couples or $25,000 for singles, you would owe taxes on the Social Security side of your income.
Rate Single Filers Married Joint Filers Head of Household Filers
10% $0 to $9,075 $0 to $18,150 $0 to $12,950
15% $9,076 to $36,900 $18,151 to$73,800 $12,951 to $49,400
25% $36,901 to $89,350 $73,801 to $148,850 $49,401 to $127,550
28% $89,351 to $186,350 $148,851 to $226,850 $127,551 to $206,600
33% $186,351 to $405,100 $226,851 to $405,100 $206,601 to $405,100
35% $405,101 to 406,750 $405,101 to 457,600 $405,101 to $432,200
39.60% $406,751+ $457,601+ $432,201+
Look at what your money would do in a 4% interest bearing account that is not tax deferred. If you were in the 28% tax bracket the real rate of return (RRR) would be 2.88%. So the 4% is not actually 4% but after taxes is 2.88% and you are not making the return that you thought. Things are not always as they seem.
That same amount of money in a TDA would look differently. Making the same 4% but in a TDA account the amount of money you could earn would be 5.56% growth because of the triple compounding affect.
You would make money on your principle, on your interest, and on your tax savings. Just by making a simple move like this it could change the outlook of your overall portfolio. Just reposition the assets you are not utilizing.
Go home, look at all of your statements and see what you are really making on these accounts. Look at what type of account it is and ask a financial adviser to help if you need help understanding what your real rate of return is.
Below is a summary of how to include Social Security income.
Your adjusted gross income
+ Nontaxable interest
+ ½ of your Social Security benefits
= Your “combined income”
Then you will see what tax bracket you reside in