5 of 10 Bizarre Things – More Is Less: Increase Your Social Security, Decrease Your Taxes

//5 of 10 Bizarre Things – More Is Less: Increase Your Social Security, Decrease Your Taxes

5 of 10 Bizarre Things – More Is Less: Increase Your Social Security, Decrease Your Taxes

Number 5 In The 10 Bizarre Things About Social Security Series…

Now this is a little bizarre. If you increase your Social Security income, shouldn’t your taxes go up? Not necessarily…

Not only could your taxes go down, but you may be able to eliminate them completely. This has to do with the special way Social Security income is reported for tax purposes.

If you have multiple sources of income in retirement and you can replace some of that income from one of those sources, such as an IRA account or 401K, with income from Social Security, you could substantially reduce or even eliminate your tax liability.

Working with a tax preparation specialist, I have prepared three scenarios that examine the potential tax liability of Social Security income when benefits are claimed at age 62, 66, and 70.

Casey and Alex are a married couple and they are both the same age. They need $60,000 of annual income during retirement. This amount is a constant, regardless of when they claim their benefits. It will cover all of their daily living expenses and allow them to also have some fun during their retirement.

If their Social Security income is not sufficient to meet their annual income requirement of $60,000, the shortfall will be made up by withdrawing money from their savings and other investments.

The longer Casey and Alex delay claiming their Social Security benefits, the larger their Social Security checks will be and the less money they will need to withdraw from their savings and other investments.

Depending on when Casey and Alex claim their Social Security benefits, the percentage of their total income requirement of $60,000, derived from Social Security, will change. Let’s examine what happens to Casey and Alex’s tax liability when they claim their Social Security benefits at ages 62, 66, and 70.

TABLE 1

Table 1 recaps the three different scenarios. Column A shows three different claiming ages. In Column B, you see the annual amount of Social Security income they will receive if they claim at that corresponding age. The numbers in Column C represent the amount of money that has to be withdrawn from their savings to meet their annual income need of $60,000, in Column D.

I have assumed that the amount withdrawn from their savings came from an Individual Retirement Account or IRA. (I have used a married couple in this example, but you do not have to be married to take advantage of these potential tax savings.)

When Casey and Alex both claim at age 62, they receive the smallest amount of Social Security income—$27,000 annually (Column B). The shortfall of $33,000 (Column C) represents the amount of annual income that has to be withdrawn from their savings and other investments, in this case their IRA account, in order to meet their annual income requirement of $60,000 (Column D).

If Casey and Alex both claim at age 66, the amount of the annual Social Security income in Column B will increase to $36,000. By increasing their Social Security income, they also decreased the amount that they had to withdraw from their IRA, in Column C, to $24,000 ($60,000 – $36,000).

Delaying until age 70 maximizes their annual Social Security income to $47,520. As a result of maximizing their Social Security income, they have to withdraw even less from their IRA, only $12,480 ($60,000 – $47,520), in order to meet their annual income requirement of $60,000.

More Social Security Income, Smaller Withdrawals and Less Taxes Owed

Table 2 shows the abbreviated tax returns for Casey and Alex at the three different ages: 62 (Column A), 66 (Column B), and 70 (Column C). Their total income remains the same. However, when their Social Security income went up and their withdrawals from their IRA went down, their taxes decreased.

TABLE 2

Assuming that both Casey and Alex claim their benefits at age 62, on Line 1 it shows Total Social Security Benefits of $27,000. Line 2 indicates they withdrew $33,000 from their IRA. Even though Casey and Alex received $27,000 in Social Security income, after going through the special calculation to determine the taxable portion, it turns out that only $8,125 of it is taxable, as shown on Line 3. In this scenario, if they both claimed their Social Security benefits at age 62, on Line 5 you can see that they would have to pay $2,529 in taxes.

Assuming that both Casey and Alex claim Social Security benefits at age 66 in Column B, on Line 1 you see that their Total Social Security Benefits increase to $36,000. That decreases the amount they have to withdraw from their IRA to only $24,000 on Line 2. Even though their Social Security income increased from $27,000 (claimed at 62) to $36,000, their Taxable Social Security Benefits on Line 3 are reduced to $5,000.

You would think just the opposite would happen—as Social Security income is increased, more of it would become taxable, not less. However, this is not the case. As their Social Security income increased, even less of it was taxable. As a result, their Total Tax on Line 5 was also reduced to only $813. When they both claimed at age 62, on Line 5, you see they pay a Total Tax of $2,529. When they both claimed at age 66, they increased their total Social Security income and decreased their taxes to only $813. That’s a tax savings of $1,716.

Column C assumes that both Casey and Alex claim their Social Security benefits at age 70. In this case, on Line 1, their Total Social Security Benefits are maxed out at $47,520. That further reduces the amount they have to withdraw from their IRA to only $12,480 on Line 2. By waiting to claim until age 70, Casey and Alex received the largest amount of Social Security income possible. Because they increased their Social Security income, they further decreased the amount of money they had to withdraw from their IRAs. Their Social Security income totals $47,520, but amazingly, on Line 3, their Taxable Social Security Benefits are a mere $2,120. It happened again! Their Social Security income increased, but even less of it was taxable. Going right to the bottom line you see that their Total Tax, on Line 5, is zero ($0).

Delaying Benefits Until Age 70, Zero Owed In Taxes

In all three of the situations we just reviewed, Casey and Alex’s total income remained the same at $60,000. If you can replace more of the taxable income you take from your savings and investments with Social Security income, the amount you pay in taxes could be reduced or, in some situations, even eliminated.

You accomplish this by delaying the claiming of your Social Security benefits as long as possible. When you do this, you will increase your Social Security income and reduce the amount you need to withdraw from your savings and investments. I am not saying that if you delay claiming your Social Security Benefits until age 70 that you will eliminate all of your tax liability, however, that is the way it worked out for Casey and Alex.

What I am saying is: if you replace some of the income you receive from your savings with income from Social Security, it could reduce the amount of taxes you have to pay.

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By |2019-03-05T15:52:40+00:00January 5th, 2017|0 Comments

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