How Much Will You Really Get From Social Security?
September 23, 2013Will Social Security be around when we need it the most…and if so when should we take it and how will it be taxed? These days, those are some of the biggest retirement planning concerns among anyone that’s not currently retired. It’s no secret that Social Security is in need of some significant changes to strengthen the ability of future generations to receive Social Security benefits. The reality is that without any changes to the system only 75-80% of projected benefits would be able to be paid.
But that doesn’t mean that Social Security is necessarily going away anytime soon and for many, it remains an essential component of retirement income plans. That’s why estimating future Social Security benefits is an important step during the retirement planning process. You can obtain an estimate of your future benefits based on your actual earnings record here or use one of the benefits planner calculations for different retirement dates and future income amounts. For many pre-retirees, delaying the start date will increase your overall lifetime benefits so it’s also important to take into account life expectancy, spousal benefits, and your overall retirement income plan while determining when to claim benefits. This calculator provides a simple illustration to help you decide when to claim Social Security.
There is one additional factor to consider when making decisions related to Social Security – taxes. Uncle Sam can show up unexpectedly when we make financial decisions without a complete understanding of how our complex income tax system works in America. Whether or not Social Security benefits are taxable depends on how much income retirees have from other sources (e.g., pension, IRAs, 401ks, rental income, part-time employment). Here is a fairly straightforward calculation you can use to determine if you will owe taxes on your Social Security benefits:
Step 1: Estimate your adjusted gross income (AGI) for the current tax year.
Note: Adjusted Gross Income is defined by the IRS as your gross income minus adjustments to income. To compare your projected AGI to the previous year, look at line 37 on Form 1040 for the 2012 tax year. Look at line 4 if you filed Form 1040EZ or line 21 if you filed Form 1040A.
Adjusted Gross Income = __________
Step 2: Add any tax-exempt interest (e.g., municipal bonds) to your AGI.
Tax-exempt interest = ___________
Step 3: Calculate your annual Social Security benefits then divide this in half.
One-half Social Security benefits = ___________
Step 4: Add the previous three steps together to determine your “provisional income.”
AGI + Tax-exempt interest + ½ Social Security benefits = __________
Step 5: Compare your “provisional income” to the base amounts for your filing status to calculate your taxable Social Security amount.
If your filing status is single, head of household, or qualifying widow(er), then your Social Security benefits aren’t taxed if your provisional income is less than $25,000. If your provisional income is between $25,000 and $34,000, 50% of your benefits are taxable. If your income is above $34,000, $4,500 plus 85% of your Social Security benefits above $34k become taxable.
For married couples filing jointly, Social Security benefits will not be taxed if your joint provisional income is less than $32,000. For joint provisional income between $32,000 and $44,000, 50% of your benefits are taxable. If your joint provisional income is above $44,000, $4,500 plus 85% of your Social Security benefits above $44,000 become taxable.
Married couples filing separately have their own unique calculation rule. If you live in the same household at any time throughout the year, a zero base amount is used and up to 85% of the benefits are taxable. Married couples filing separately who lived apart during the entire year use the same base amounts as single individuals.
It is important to keep in mind that this doesn’t mean your tax rate could either be 50% or 85%. This calculation simply refers to how much of your Social Security benefits will actually be taxable at ordinary federal income tax rates (10%, 15%, 25%, etc.). Here is the current federal tax rate table for 2013. Are you ready for a simpler and more efficient income tax code yet?
If you are approaching retirement, it’s important to keep in mind whether or not you will be subject to income taxes on your Social Security benefits. Paying attention to your income from all sources (including 401k or IRA distributions) will help you avoid any tax surprises when it is time to file your return. Understanding the tax implications related to Social Security can also help you determine if tax-free savings vehicles such as Roth IRAs and Health Savings Accounts (HSAs) fit into your financial life plan.
If you are subject to taxes on Social Security benefits, consider requesting that federal taxes be withheld by downloading Form W-4V from www.ssa.gov. Another important resource to take advantage of is a good tax calculator provided by most online tax preparation software providers such as TurboTax, TaxAct, TaxSlayer.com, and H&R Block (to name just a few options out there). Financial planning is an ongoing process and a solid income tax plan should be a part of your routine financial checkup. A quick calculation like the one above can make the difference between a proactive retirement income plan and a nasty tax surprise from Uncle Sam.