Paring The Tax On Your SSA Benefits

Defensive Steps Help

The IRS' bite from your monthly check enlarges as your income grows

Rules regarding the taxation of Social Security benefits are complicated. But good planning can pare some retirees' payments to Uncle Sam.

To start, calculate your modified adjusted gross income (MAGI). That is the total of:

All taxable income reported on your return, excluding Social Securtiy benefits.
Tax-exemp interest income.
Half of your Social Security benefits.
Say a hypothetical John Williams has $20,000 in taxable income this year. He gets $3,000 in tax-exempt interest from municipal bonds.

In addition, Williams receives $14,000 in Social Security benefits. One half of that is $7,000.

So his MAGI is $30,000: $20,000 plus $3,000 plus $7,000.

If his MAGI were under $25,000 as a single filer he'd owe no tax on Social Security benefits. On a joint return, this threshold is $32,000.

The higer is MAGI goes above those levels, the more Williams' Social Security benefits would be subject to income tax.

Say Williams is a single filer. With $30,000 of MAGI, he's over the $25,000 mark. Up to 50% of his benefits will be subject to inocme tax.

An even larger portion of benefits is taxable for someone whose income is in a higher range. The thresholds are MAGI of $34,000 for singles and $44,000 for couples. Once you top them, the 50% ceiling becomes an 85% ceiling.

Those thresholds are not indexed for inflation. So retirees whose incomes increase over time may pay more tax on their Social Security benefits.

But don't confuse the 50% and 85% numbers with tax rates. Those are the amounts of your Social Security benefits that may be subject to tax at your regular income tax rate.

Figuring out that tax rate on your befefits requires another calculation.

Go back to Williams. He has a MAGI of $30,000. That is $5,000 over the $25,000 threshold. He'll start by taking half of the excess: $2,500.

As mentioned, Williams gets $14,000 in Social Security checks. Half of that is $7,000.

Then he'll compare the $2,500 and $7,000 numbers. The smaller - $2,500 - will be added to his taxable income.

If Williams is in a 15% tax bracket, he will owe $375 in tax on his Social Security benefits: 15% times $2,500.

The calculation for determining whether 85% of your benefits is subject to taxation involves many steps. It applies to people far above the $34,000 and $44,000 thresholds.

Look what happens to another hypothetical person we'll call Al Jones. His MAGI is $100,000. That makes 85% of his benefits taxable.

If he recieves $24,000 from Social Security, $20,400 of those benefits will be added to his taxable income and taxed at his income tax rate.

What defensive planning can you do?

With lower inocme, nothing needs to be done. If your retirement MAGI will be lower than $25,000, or $32,000 on a joint return, your Social Security benefits won't be taxed.

At the other end of the spectrum, if your MAGI will be far higher than the $34,000 and $44,000 thresholds, you will owe income tax on 85% of your benefits. You can't do anything about it.

Keep in mind that those are not "cliff" thresholds. If your MAGI on a joint return is $44,001, the amount of your benefits subject to tax doesn't jump all at once to 85%.

The share of your benefits subject to tax rises in steps to the 85% cap. Steps often vary from one taxpayer to another. They depend mainly on level of MAGI and benefits.

Generally, you will owe tax on 85% of your benefits when your MAGI is north of $50,000 on a single return, above $60,000 on a joint return.

The rungs up that ladder will differ, according to individual circumstances.

IRS publication 915 shows you examples.

Bottom line: As a single filer, if your MAGI is between say, $25,000 and $50,000, some strategic steps can be helpful. The same can be true with MAGI of $32,000 to $60,000 on a joint return.

Planning steps are most likely to help people who can reasonably try to bring their MAGI well uner $50,000 or $60,000.

One tactic is to invest in low-dividend and no-dividend stocks. If you buy and hold, they will produce little or no MAGI, which can hold down the tax you'll owe on Social Security benefits.

Another tactic: take stock market losses when you can. They can offset any capital gains you incur. And you can cut your MAGI by up to $3,000 of net capital losses each year.

MGI Moves

You also may convert a traditional IRA to a Roth. That'll lift your MAGI in the year of conversion. But it can cut MAGI in later years because Roth distributions don't count in this calculation, after you hold the account for five years and you reach age 59 1/2.

Under these conditions, withdrawn Roth IRA contributions never are taxable.

Other tactics include investing in deferred annuities.

Don't rearrange your financial plan to save taxes on Social Security benefits. But they are a factor to consider when deciding from where retirement income will come.$

Ray Buckner (Chicago, Illinois) provides personal financial planning and wealth management services for professionals in the greater Chicago metropolitan area. His primary focus is serving pre-retirees who are preparing for a successful retirement as well as those who have already retired and want to develop a 100% retirement income personal paycheck. His pre-retiree clients want to focus on replacing 100% of their last year's income and keep their current standard of living through out their retirement adjusted each year for inflation.
www.promoneyreports.com/rbuckner