Q: My wife and I are reaching the point where we have to make a decision on how to handle our Social Security options. We're aware that if she takes Social Security at age 62, she'll be subject to an annual earnings cap. We file a joint tax return. If my wife takes Social Security early, and I continue to work until age 70, is it possible that she will forfeit some of her benefits depending on how much I earn? --JC via email
A: No. The earnings cap that affects her Social Security benefit applies only to her personal income. But your joint income will determine whether or not some of her Social Security benefit is taxable.
Social Security's annual earnings cap applies to people who are collecting a benefit while under their full retirement age. Until the year your wife turns 66, she will forfeit $1 of benefit for each $2 she earns above an annual limit. This year, that limit is $14,160. So if she earned $24,160 in 2010, she'd forfeit $5,000 of her Social Security benefit for the year.
After she turns 66, she can earn an unlimited amount while collecting Social Security without forfeiting any of her benefit. (And when she turns 66, the Social Security Administration will recalculate her benefit amount, so she'll recoup what she forfeited earlier.)
Clear so far? Okay, then let's talk income taxes.
Internal Revenue Service rules are what determine whether any of her Social Security benefit is taxable, and of course the IRS looks at your joint income -- or to be more precise, your joint 'provisional' income.
If your joint provisional income is between $32,000 and $44,000, up to 50% of your Social Security benefits may be taxable. If it's more than $44,000, up to 85% of your benefits may be taxable.
Don't read that so quickly that you assume it means that your Social Security benefit could be subject to an 85% tax bite!
It means that 85% of your Social
Security benefit is added back into your taxable income.
"For
example, let's say you get $12,000 a year in Social Security benefits, you're
married filing jointly, and your provisional income adds up to more than
$44,000," says Ed Slott, a Rockville Centre New York tax accountant. "That means 85% of your Social Security benefit, or $10,200, is
taxable. If you're in a 25% tax bracket, your tax on that amount would be
$2,550."
You can reduce your vulnerability to taxes on your Social Security benefit by contributing to a tax-deferred retirement plan, he adds. Contributions to a 401(k) plan, for example, are subtracted from your taxable wages, so they aren't included in your provisional income.
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(c:) Lynn Brenner, All Rights Reserve