Yes, the countdown to Tax Day is on and for many it isn’t a pretty sight. A number of the COVID-related tax breaks have expired, and some folks will find themselves paying in more dough to make up for financial concessions during the pandemic. For example, those who took penalty free withdrawals from retirement plans during COVID need to start paying those taxes back. The same goes for some small business owners and contractors, who were able to delay payroll taxes. These were required to be repaid in full by January 1, 2022.
Now, most folks would agree that there are very tangible benefits to paying our taxes. After all, we all benefit from roads, schools, our police and firefighters, national security, and many other services and perks. But I have yet to meet anyone who wants to pay more than their fair share. And yet the one tax that seems to surprise so many folks is the taxation of Social Security. You see, these benefits could be subject to income taxes so the topic needs to be part of your retirement planning system.
I had this very conversation recently with some folks who came to see me about building a sound retirement system, I will call them Dave and Janet. Dave’s a former project manager for a construction company and had retired 3 years earlier at age 62, while Janet continued to work as a medical technician. Now that she is approaching 65, too, they wanted to make sure their affairs were in order before she pulled the plug on her healthy paycheck.
After analyzing their portfolio and creating a plan for steady income in retirement, we went through the exercise of classifying assets by their tax type – taxable, tax deferred and tax-free. It was during this process that their eyes were opened to the very real possibility that they would be taxed on their Social Security benefits.
I know, just what does this mean? Get this, it means that their income, as joint filers, couldn’t exceed $32,000 if they wanted to avoid their benefits being taxed! Dan and Janet anticipated that they’d need to draw about $4,500 from their assets each month in addition to their Social Security benefits in order to enjoy the retirement they’d envisioned. That’s a far cry from the earnings limit, which comes to about $2,667 each month. So as things stood, they were going to be taxed on the bulk of their retirement plan distributions and then also taxed on their Social Security benefits (up to 85% of them).
Former Federal Reserve chair Alan Greenspan’s commission instituted this tax back in 1984, and the tax thresholds have never been indexed for inflation. That means for this year, Social Security benefits will be taxed if your income tops $25,000 a year (or $32,000 for joint filers). During the past 38 years, wages and consumer prices have tripled, yet the thresholds haven’t moved at all.
Back in 1984 the median family income was $26,000. Today it’s about $80,000. “Unlike other federal income taxes, Congress has never adjusted the income thresholds that subject Social Security benefits to taxation since the tax became effective in 1984,” says Senior Citizen’s League analyst Mary Johnson. To make matters worse, when the tax was introduced, it only applied to 50% of your benefits. But today, thanks to further tax hikes introduced in 1993, it quickly goes up to 85% of your benefits. Once your income tops $34,000 a year, or $44,000 for joint filers, you’re in the 85% zone. Unfortunately, Dan and Janet found themselves in this maximum tax zone, too.
I can see some logic for taxing up to 50% of your Social Security benefits because for most folks, your employer technically paid half your Social Security contributions, and they can deduct that cost against their corporate income tax. But that’s 50%, not 85%, so the higher rate makes no sense at all to me. It’s just pure profit for our Washington Wizards on capitol hill.
Initially, this tax affected roughly the top 10% of Social Security recipients, but today it now hits about half. The Senior Citizens League, a group that represents seniors, states that the number of folks expecting to pay this tax is 49%, up from 47% the year before₁. So, what started out as a means of taxing only the very rich now affects about half of the US tax-filing population.
This is a big deal for our Wizards. This tax created approximately $41 billion in revenue for them, according to the trustees’ latest report. It’s expected to increase to about $44 billion this year. Worse yet, the Social Security administration is expecting the tax take to double over the next seven years and to hit $100 billion a year within a decade!
While you and I can’t control the tax laws, we can take steps to minimize what we must pay. There are numerous strategies available to help you reduce your taxable income, thus reducing the taxes on your Social Security benefits. The trick is understanding how you’ll be taxed and then taking steps to reduce it sooner than later. As Arthur Godfrey once said, “I’m proud to pay taxes in the United States; the only thing is, I could be just as proud for half the money.”
So as always – be vigilant and stay alert, because you deserve more!
Have a great week.
Jeff Cutter offers investment advisory services through Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield.
Jeff can be reached at email@example.com. Insurance products, including annuities, are offered through Cutterinsure, Inc., (MA insurance license #2080572). Cutter Financial Group and Cutterinsure are affiliated and under common control but offer services separately. Members of Cutter Financial Group’s management receive revenue directly from Cutterinsure. Any compensation received is separate from and does not offset regular advisory fees. Cutter Financial Group does not charge advisory fees on any insurance products. We do not offer tax or legal advice. Always consult with qualified tax/legal professionals regarding your own situation. Investing in securities involves risk, including possible loss of principal. Insurance product guarantees are backed by the financial strength and claims-paying ability of the issuing company. This article is intended to provide general information. It is not intended to offer or deliver investment advice in any way. Market data and other cited or linked-to content in this article is based on generally available information and is believed to be reliable. Please contact us to request a free copy of Cutter Financials’ Form CRS, Form ADV 2A and applicable Form ADV 2Bs. 1. https://tinyurl.com/3r6kdm5f