For those who think your Social Security benefit comes to you free and clear, think again. For a good amount of baby boomers, Uncle Sam will most likely have his hand out when it comes time to pay your taxes.
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Mike Lynch, Vice President of Strategic Markets for Hartford Funds, provided FOXBusiness.com with some tips on how to manage your Social Security taxes when nearing or in retirement.
Boomer: Have Social Security benefits always been taxed? Is there any legislation in the works to remove the tax liability for seniors?
Lynch: No, Social Security benefits were not taxable until 1983 with the enactment of the Amendments to Social Security Act. Beginning in 1984, a portion of Social Security benefits have been subject to the federal income taxes. Unfortunately, there has not been any public discussion regarding eliminating the taxation of Social Security. Social Security is a program that has been around since 1935. It has gone through a number of changes in the past, and will most likely continue to do so in the future to ensure its survival.
What you can do today is begin to think about tax diversification. You may have heard the term regarding investment diversification and being well diversified. It is important to also think about tax diversification, meaning having some money in taxable, tax deferred, and tax free investments. Working today with your tax professional to ensure you are well diversified from a tax perspective can only help you down the road as you enter retirement, regardless of changes to social security taxation.
Boomer: How do I figure out if my Social Security is taxable?
Lynch: The first step in determining your tax liability on your Social Security benefit is to determine your “Combined Income.” Generally, combined income can be determined by adding your adjusted gross income + ½ of your Social Security benefits + nontaxable interest. For more information, taxpayers can refer to IRS Publication 915 and, of course, speak with a tax advisor for specific advice.
For someone filing a federal tax return as an individual:
? If combined income is less than or equal to $25,000, you will not have to pay federal income taxes on your benefits.
? If combined income is more than $25,000 and less than $34,000, you may have to pay income tax on up to 50% of your benefits.
? If combined income is more than $34,000, up to 85% of your benefits may be taxable.
For someone filing a federal tax return jointly:
? If combined income is less than or equal to $32,000, you will not have to pay federal income taxes on your social security benefits.
? If you and your spouse have a combined income that is more than $32,000 and less than $44,000, you may have to pay income tax on up to 50% of your benefits.
? If the combined income is greater than $44,000, up to 85% of your benefits may be taxable.
If you are married and filing a separate tax return, you probably will pay taxes on your benefits.
Boomer: What steps can be taken to avoid paying taxes on Social Security or at least minimize my liability?
Lynch: There are three things that you can do today, prior to taking your Social Security benefits:
1. Determine your benefit amount. If you haven’t yet, the first step is to go onto the ssa.gov website, setup an account, and run an illustration for yourself to determine your benefit amounts at specific ages (62-70).
2. Determine the “what.” Many folks I speak with want to know the magic year or optimal age to take benefit payments. There are a number of factors that will determine this, and there is no “right” time or age. It really depends on your specific situation. What I have found helpful, though, is to determine the “what” rather than the “when.” What income do you need? What income do you and your spouse need? Once you determine your “what,” you can go back and reevaluate the strategies behind when you file and when your spouse files, so that you can get as close to your “what,” your desired dollar amount, as possible.
3. Develop a team. Pull together trusted tax, legal and financial professionals who can work together and with you to develop your plan.