Social Security benefits were not taxable before 1984. In 1984, 50% of Social Security benefits became taxable, and only to those taxpayers whose income exceeded a set threshold amount. In 1993, the maximum of Social Security benefits subject to taxation increased to 85%, again with thresholds in place. The result is Social Security benefits are currently either 0%, 50% or 85% taxable. For clients with provisional income (the clients adjusted gross income, plus tax-free interest, less Social Security benefits, plus one-half of Social Security benefits) of:
- Under $25,000 ($32,000 for joint), 0% of the Social Security benefits will be taxable.
- Between $25,000 and $34,000 ($32,000 and $44,000 for joint), up to 50% of the Social Security benefits will be taxable.
- Over $34,000 ($44,000 for joint), up to 85% of the Social Security benefits will be taxable.
For most clients, 85% of Social Security benefits will be taxable, and tactics to reduce the client’s taxable income is unlikely to reduce the taxability of their Social Security benefit.
However, for clients whose income is just over the threshold amount for the 85% benefit taxation, planning can lead to a significant tax savings over the years.
This article from FinancialPlanning.com discusses which clients can benefit from strategies to reduce Social Security taxation and offers five strategies to utilize. You can read more about each strategy in the Financial Planning.com article.
The taxation of Social Security benefits is uber-complicated,
but savvy planning can pay off for select clients.
By Donald Jay Korn
April 1, 2012
Five planning strategies to reduce Social Security taxation:
- “Change investments. To lower a tax bill, some advisors suggest that clients alter their investment strategies. For some, that could be as easy as investing in an annuity, says Mary McGrath, executive vice president of Cozad Asset Management in Champaign, Ill. “They can avoid reporting the income until money is withdrawn,” she says.”
- “Gauge gains. “Seniors should be careful about recognizing capital gains,” McGrath says. “The actual tax can be much greater than 15% if the capital gain causes Social Security to be taxed.” Harvesting capital losses can help hold down taxable capital gains.”
- “Fund retirement accounts. Some tax-deductible contributions can keep combined income in check. For seniors who earn small amounts from self-employment, “This income may be sheltered by adopting and contributing to a Simple IRA,” McGrath notes. Earned income up to $14,000 can be fully sheltered from taxes this year with a Simple IRA. Tax-deductible IRA or Keogh contributions should be considered, Abo says.”
- “Consider Roth IRA conversions. “If a client converts a traditional IRA to a Roth IRA, Social Security benefits will probably be taxed that year because the conversion increases taxable income,” Abo says. Clients might want to make smaller conversions spread over a few years. “I’ve also seen taking a onetime tax hit turn out to be worthwhile,” he says. Withdrawals from a traditional IRA or a 401(k) are counted as taxable income, but converting to a Roth IRA may avoid taxes on future distributions because Roth IRA withdrawals eventually are tax-free and will not be included in the Social Security taxation calculation.”
- “Delay Social Security. “I have clients delaying Social Security while converting to a Roth IRA,” says Mark Lumia, who heads True Wealth Group in The Villages, Fla. This tactic will let their qualified money grow tax-free in a Roth IRA, and they may not have to take required minimum distributions at age 701/2.”
FinancialCalculators.com has a free calculator you can use to determine a client’s provisional income and the amount of the client’s Social Security benefit subject to income tax: http://www.calcxml.com/do/inc08
Money Tree Software’s advanced Cash Flow program, Golden Years, provides full detailed tax calculations and determines how much of the client’s Social Security benefits will be taxable each year. Thanks to the detailed calculations in Golden Years, this is great planning tool to help manage a client’s income sources to aid in tax reduction strategies.
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