AFTER YEARS OF PLANNING for that perfect retirement, many investors miss one important detail: As much as 85% of your Social Security income could be subject to federal (and possibly state) income taxes. How much depends on a variety of factors.
Social Security benefit taxes are based on what is commonly referred to as your provisional income. That includes half of your Social Security income for the year, plus your modified adjusted gross income. After you cross the income threshold — $25,000 if you file as single, or $32,000 for married couples filing jointly — a portion of your Social Security benefits will be considered taxable income.
Because of these income thresholds, tax planning experts often advise looking for ways to lower your provisional income. For example, if you anticipate a big one-time event such as the sale of a business, you may be better off structuring it as an installment sale to be paid off over several years instead of an all-cash transaction. This can help evenly distribute your overall income and possibly keep you in a lower tax bracket, which could help minimize that tax hit on your Social Security benefits.
Consider a longer-term strategy for drawing from your qualified retirement accounts. Withdrawals from a traditional IRA generally will be included in your provisional income calculations. Qualified withdrawals from a Roth IRA, however, generally are not included. So, if you have both, you may want to carefully consider whether you should make withdrawals from your Roth or traditional IRA first.
Those hoping to work in retirement need to be especially careful if they are planning to claim Social Security benefits early. The Social Security Administration (SSA) caps how much you are allowed to earn if you start taking your benefits before full retirement age, which the SSA considers 66 for most baby boomers. In 2017, the annual earned income cap is $16,920, and for every $2 you earn over that limit, the SSA trims $1 off the top of your benefits. So if you earn $20,000 this year, and you have not yet reached full retirement age, your benefits will be reduced by $1,540 — on top of any income taxes you may have to pay on the remaining benefits.
There is some good news, however: Because the penalty is determined by your individual earned income, if you retire early and your spouse does not, and if you file separately, your spouse’s earned income will not be factored into any benefit cuts that could apply. However, if you file jointly, your spouse’s earnings will be included when calculating your provisional income. Additionally, when you reach your full retirement age, the earned income penalty disappears.
Worksheets in IRS Publication 915, “Social Security and Equivalent Railroad Retirement Benefits,” available at www.irs.gov, can help you compute your tax liability. As always, your financial advisor can work with your tax professional to find appropriate solutions.
For more information, contact The Menashe Morley Group in the Rancho Santa Fe office 858-381-8113. The Menashe Morley Group, serving the community for over 34 years: David Menashe is a Senior Vice President and Wealth Management Advisor, Bruce Morley CRPC ® is a First Vice President and Wealth Management Advisor and John Naviaux CPWA ® is a Vice President and Wealth Management Advisor. Merrill Lynch makes available products and services offered by Merrill Lynch, Pierce, Fenner & Smith Incorporated (MLPF&S) and other subsidiaries of Bank of America Corporation. Investment products: Are Not FDIC Insured, Are Not Bank Guaranteed, and May Lose Value. MLPF&S is a registered broker-dealer, Member SIPC and a wholly owned subsidiary of Bank of America Corporation. Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions. © 2017 Bank of America Corporation. All rights reserved. ARC59SBW