When Is Part of Your Social Benefit Taxable Income?

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.

Your `provisional income' is half of her total Social Security benefit plus all the other income declared on your joint tax return: investment income (including tax-exempt interest), pension income, withdrawals from your retirement accounts, and, of course, your wages.

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. tax accountant. Or to put it another way, at least 15% of your Social Security benefit is tax-free no matter how much you earn.

"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. 

Please send your questions to [email protected].  I'm sorry I can't respond personally to every email. Questions are only addressed online.

 (c:) Lynn Brenner, All Rights Reserve

Comments

[Carolyn]

(And when she turns 66, the Social Security Administration will recalculate her benefit amount, so she'll recoup what she forfeited earlier.)
Please explain this statement. What do you mean by recoup what she forfeited earlier. What would that mean in the long run once reaching age 66. Does that mean once 66, possibly receive more in monthly benefit amount? What? At 62 I went to check out about my benefits. I brought this statement up and they basically told me I was crazy, their was no such thing.

[Lynn Brenner]

Lynn replies: The following question and answer are from the Social Security Administration's own website:

"Will you receive higher monthly benefits later if benefits are withheld because of work?

"Yes. If some of your retirement benefits are withheld because of your earnings, your benefits will be increased starting at your full retirement age to take into account those months in which benefits were withheld.

"As an example, let us say you claim retirement benefits upon turning 62 in 2010 and your payment is $750 per month. Then, you return to work and have 12 months of benefits withheld. We would recalculate your benefit at your full retirement age of 66 and pay you $800 a month (in today’s dollars). Or, maybe you earn so much between the ages of 62 and 66 that all benefits in those years are withheld. In that case, we would pay you $1,000 a month starting at age 66."

(You'll find it here: http://ssa.gov/pubs/10069.html#receive)

In other words, if you claim Social Security at 62, but keep working and earn above the annual limit, and as a result, a year's worth of your benefit is withheld, in the long run it's as if you'd retired at 63.

[Maiane]

if you do not have a brokerage firm get one. (I use Edward Jones). Roll over everything to the account, then figure out how much you want each month; 2 years worth in their money market. Invest 2nd thru 5th years each into ladder cds with dividends going into the money market to have for a rainy day fund. Put the rest in to good corp bonds and mutual funds. I did this at 59.5 and never looked back. I am now 67. I get over 13K a year out and my fund has been growing each year!!!

[Norma]

Roll your 401k into an on line brokerage IRA account and then invest in money market funds or shorter term CDs. You want to roll the 401k into an IRA so that you can maintain the tax deferral as long as you can. On the cash you retain and the subsequent withdrawals there will be regular income tax but because you are over age 59 1/2 there is no 10 % penalty.