By Keith McCullough, Director of Support Services

8465_WEB_Covisum_blog-graphics-tax.jpgMany of us have heard someone say that Social Security is not going to be around much longer. There are claims that the Social Security Administration will run out of money and will not be able to pay out benefits. Along with those claims comes the suggestions that one should file for benefits as soon as possible. You know, “…it’s better to get a little something back considering you’ve paid into the system for all your working life.”

There have been a number of changes to Social Security benefits over the years. You could say this has been to adapt to the evolving changes in our society. The full retirement age (FRA) for example, has increased from 65 for those born in 1939 or earlier to 67 for those born 1960 or later. Same sex married couples now share the same benefits previously granted to heterosexual couples. Claiming strategies are being phased out... to name a few. 

So what are some of the implications of filing for benefits early versus filing late? First, consider that you will be taking a reduced benefit for filing early. For example, if your FRA is 66 and your benefit at that age is $2,000, you only receive 75% of that amount or $1,500 filing at 62 (i.e., the earliest you are eligible to file).

Second, you’ll be subject to provisional income tax. Depending on your filing status, the limits and amounts will vary.  For a married couple with income over $44,000 or a single with income over $34,000, your Social Security benefit is taxable up to 85%.

Let’s explain how provisional income tax affects a Social Security benefit in the case where one filed early versus one who filed late. Assume a married couple needed an income of $65,000 for living expenses. For the early case, $20,000 of that need comes from an early filed Social Security benefit and $45,000 from an IRA withdrawal.

  • The provisional income calculation includes half of the Social Security benefits, plus all other taxable income
  • $55,000 is provisional income (half of $20,000 Social Security benefits + $45,000 IRA withdrawal)
  • $55,000 minus the first threshold of $32,000 is $23,000 taxed at 50%. $23,000 X .5 = $11,500
  • $55,000 minus the second threshold $44,000 is $11,000 taxed at 35%. $11,000 X .35 = $3,850
  • Total taxable benefit $15,350 which is 76.8% of the Social Security benefit $20,000

Now let’s examine a case where the same couple delayed taking their Social Security benefits to where it is now $40,000. They only need $25,000 IRA withdrawal to meet their $65,000 income requirement.

  • The provisional income calculation includes half of the Social Security benefits, plus all other taxable income
  • $45,000 is provisional income (half of $40,000 Social Security benefits + $25,000 IRA withdrawal)
  • $45,000 minus the first threshold of $32,000 is $13,000 taxed at 50%. $13,000 X .5 = $6,500
  • $45,000 minus the second threshold $44,000 is $1,000 taxed at 35%. $1,000 X .35 = $350
  • Total taxable benefit $6,850 which is 17% of the Social Security benefit $40,000

From our example, we can clearly see tax efficiency implications of a Social Security benefit. Covisum has tools to help you get the most of a Social Security benefit, and determine the amount of taxes that Social Security benefit is subject to. Try Social Security Timing and Tax Clarity today.

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