Social Security Planning and the Inevitability of Taxes

Social Security benefits are a big part of most American’s retirement plans both pre- and post-retirement and can assist you in successfully funding your retirement if you are thoughtful, intentional, and understand your options. In fact, many retirees use Social Security to provide replacement income in the distribution phase of their retirement.

That all sounds pretty simple and easy doesn’t it? Kind of like finding money in the pocket of an old pair of pants. However, we all know that isn’t necessarily true.

The sad truth is that even Social Security benefits are taxed and knowing how those benefits will be taxed for your specific situation is mission critical information.

Paying taxes is always painful and hits everybody hard but paying taxes on your Social Security benefits is even more offensive because in many cases it comes as a surprise. Retirees may not even be aware that they could be taxed on these benefits, however with a little planning you may be able to avoid having the IRS take a big bite out of your benefits.

Our Process

We began talking about retirement income planning and ways to make tax-sensitive decisions in that process. The next step in our process at My Legacy Group is calculating your specific provisional income long before you even think about starting to collect Social Security benefits. We do this so that we are able to use your Social Security as tax-advantaged because we know exactly how much of it will be taxed.

Our overarching focus when helping you plan for retirement and your legacy is to be vigilantly focused on the impact taxes may have on your savings and adjusting your plan to ensure that you are set up to weather tax implications in the most advantageous way.

What is Provisional Income

Once you begin to collect Social Security benefits the IRS will calculate your “provisional income”. The Provisional Income Calculation or PIC is used by the IRS to determine how much of your Social Security benefits will be taxed. They do this by looking at the result of your calculation against the income thresholds they have in place. They then tax you according to those thresholds.

• The threshold for married couples is $44,000
• The threshold for single individuals is $34,000

The bad news is that if you are over either of these threshold you will be required to pay taxes on up to 85% of your Social Security benefits. Not too good, right?

Knowledge is Power

Knowing your PIC in advance can make all the difference. If you don’t know what side of the threshold you fall on you could unwittingly set yourself up to pay a large and unnecessary amount of tax on money you have saved throughout your working years. Once we know your PIC we can make the necessary changes to move you below the threshold by repositioning some of your retirement accounts from forever taxed to never taxed accounts.

So, why is avoiding the taxation of your Social Security benefits so important? Let’s look at a typical scenario.

Say we have a married couple whose combined monthly Social Security benefit is $3,500.00 per month. This payment starts at their eligible retirement age, 67 and they live to a nice old age in line with the average life expectancy for Americans.

The Net Present Value or NPV of all of the Social Security payments the couple would receive would be approximately $1,000,000. If their provisional income is above the $44,000 threshold, and they didn’t know or plan ahead of time they would have to pay taxes on those benefits. That would decrease the NPV of their benefits to approximately $700,000.

They would essentially give up $300,000 in Social Security benefits to taxes that could have been avoided. My Legacy Group can help you avoid that painful possibility.