10 Bizarre Things About Social Security - Part 6: Decrease Your Taxes AND Increase Your Social Security
Now, doesn't a decrease in taxes and an increase of Social Security Income sound wonderful, albeit, 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 is because Social Security income is reported for tax purposes.
Do you have multiple sources of income in retirement? 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 for you to learn from. They examine the potential tax liability of Social Security income when benefits are claimed at age 62, 66, and 70.
Casey and Alex's Social Security: How to Increase Their Social Security Amount
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.
What if their Social Security income isn't enough to meet their requirement of $60,000? Well, 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. This would lead to less money being withdrawn from their savings and other investments.
Depending on when they claim, 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 at ages 62, 66, and 70.
This table shows 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 at that age. The numbers in Column C represents the money needing to be withdrawn from their savings to meet their annual income need of $60,000, in Column D.
I have assumed that the amount withdrawn from their savings came from an Individual Retirement Account or IRA. Please note, 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.
Claiming at Age 62
If Casey and Alex both claim at 62, they receive the smallest amount of Social Security income. This would be $27,000 annually (Column B). The shortfall of $33,000 (Column C) represents the amount that has to be withdrawn from their savings and investments. In this case I use their IRA account in order to meet their annual income requirement of $60,000 (Column D).
Claiming at Age 66
If they both claim at 66, the amount of the annual Social Security income will increase to $36,000. By increasing their Social Security income, they also decreased the amount that they had to withdraw from other accounts, in Column C, to $24,000 ($60,000 - $36,000).
Claiming at Age 70
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!
How Casey and Alex's Can Decrease Taxes and Increase Their Social Security Amount
Table 4 shows the abbreviated tax returns for Casey and Alex at the three different ages: 62, 66, and 70. 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.
Assuming they both 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 from Social Security, it turns out that only $8,125 of it is taxable (see 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 they both claim Social Security benefits at age 66, 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).
Delay Benefits Until Age 70 and Owe Zero Taxes
In all three of the situations we just reviewed, Casey and Alex’s total income remained the same at $60,000. Replacing more of the taxable income you take from your savings with Social Security income, will reduce your taxes or, in some situations, even eliminate them!
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.
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.
That is just 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.
And that is how you can decrease your taxes and increase your Social Security Amount!
This is Part 6 of a 10 part series. Keep your eyes open for more Social Security tips and advice coming soon.
1: Your Ex-Spouses Could Receive Your Full Social Security Benefit If You Die Before Them
2: Social Security’s Viagra Benefit
3: How to Get a Large Lump Sum Check from Social Security
4: Divorces Could Greatly Increase Your Social Security Income
5: Even In Poor Health, You May Want To Delay Social Security
