Taxation of Social Security

[PatrickA5]

I was playing around on the Social Security estimator website, just trying to get a feel for what my wife and I could expect to receive at different ages. We're both 57, and my first thought was to just assume we'll wait until 70 and see what that payout amount would be. Turns out it was around 66K for the both of us (at 70). Then I got to thinking half of that amount is pretty close to making the payments taxable by itself - without even adding any other income in.

Then, I notice there was a button to calculate my payments using "future" dollars. You can probably see where this is going. At age 65, we would get enough SS (by itself) to make the payments taxable. If we waited until 68, the payments (again, by itself) would be enough to make the maximum 85% of payments taxable.

I think I can officially stop worrying about ways to try and keep my SS from being taxable. It ain't going to happen. And if Congress never changes the tables to reflect inflation, my guess is in the not too distant future EVERYBODY will be paying taxes on SS payments - not just the people with a lot of other income.

 

[pb4uski]

Tax brackets are now indexed for inflation so I don't think your analysis and conclusion is correct.

http://www.irs.gov/uac/Newsroom/Annual-Inflation-Adjustments-for-2013

 

[PatrickA5]

The bottom thresholds for determining if part of SS payments should be included in taxable income haven't changed since 1983 when for the first time SS payments "could" be taxable for "higher income" individuals. At that point it was up to 50% of payments could be taxable. In 1993 Congress amended the law to make up to 85% of social security payment subject to income tax based on a stepped up feature in the calculation. These thresholds have never been adjusted to inflation and at some point most people will pay taxes on their SS payments - even without other income.

 

[jclarksnakes]

There probably are some people on this forum who will not have to pay taxes on their SS but I would bet that there are not very many.

 

[ERhoosier]

From the 'horse's mouth'. See pg 14

https://www.socialsecurity.gov/pubs/EN-05-10035.pdf

 

[foxfirev5]

One thing I'm sure of is that there will be backdoor tax consequences that many here are not anticipating. We all tend to plan based on the present situation but that may not hold true for the future.

 

[thefinancebuff]

People often compare SS to a pension (some people get public pension in lieu of SS). Pension payments are taxable. I don't see a problem with making SS 100% taxable from the first dollar. Even when it's up to 85% taxable, if that's all you have, don't you still have a layer tax free?

 

[samclem]

And if Congress never changes the tables to reflect inflation, my guess is in the not too distant future EVERYBODY will be paying taxes on SS payments - not just the people with a lot of other income.

My guess is that this is what will happen. If inter-generational friction increases, I think it may be a hard sell to convince people that SS benefits should be treated more favorably than earned income.
Both the employee and the employer contribution to SS are "before tax" IIRC. So, to the extent that an individual's SS check results from that contribution, a case will be made that it all should be taxed on "withdrawal" (since it wasn't taxed before it went in). This may be a weak rationale, since the link between contributions and payout isn't very tight, and the "account" isn't owned by the individual, isn't technically a contractual obligation, etc.

 

[Independent]

I was playing around on the Social Security estimator website, just trying to get a feel for what my wife and I could expect to receive at different ages. We're both 57, and my first thought was to just assume we'll wait until 70 and see what that payout amount would be. Turns out it was around 66K for the both of us (at 70). Then I got to thinking half of that amount is pretty close to making the payments taxable by itself - without even adding any other income in.

Then, I notice there was a button to calculate my payments using "future" dollars. You can probably see where this is going. At age 65, we would get enough SS (by itself) to make the payments taxable. If we waited until 68, the payments (again, by itself) would be enough to make the maximum 85% of payments taxable.

I think I can officially stop worrying about ways to try and keep my SS from being taxable. It ain't going to happen. And if Congress never changes the tables to reflect inflation, my guess is in the not too distant future EVERYBODY will be paying taxes on SS payments - not just the people with a lot of other income.

I'm having trouble with your math (or maybe I'm having trouble with my math).

I used this worksheet http://apps.irs.gov/app/vita/content/globalmedia/social_security_benefits_worksheet_1040i.pdf
and assumed our only income was $100,000 of SS benefits.

Line 7 = 50,000
Line 8 = 32,000
Line 9 = 18,000
Line 10 = 12,000
Line 11 = 6,000
Line 12 = 12,000
Line 13 = 6,000
Line 14 = 6,000
Line 15 = 5,100
Line 16 = 11,100
Line 17 = 85,000
Line 18 = 11,100

In this case, 11.1% of the $100,000 SS benefit gets into AGI.

 

[Independent]

My guess is that this is what will happen. If inter-generational friction increases, I think it may be a hard sell to convince people that SS benefits should be treated more favorably than earned income.
Both the employee and the employer contribution to SS are "before tax" IIRC. So, to the extent that an individual's SS check results from that contribution, a case will be made that it all should be taxed on "withdrawal" (since it wasn't taxed before it went in). This may be a weak rationale, since the link between contributions and payout isn't very tight, and the "account" isn't owned by the individual, isn't technically a contractual obligation, etc.

I'm pretty sure that the "employee half" of SS taxes does not reduce federal taxable income. So I'd say that portion is "after tax".

This was probably the rationale (excuse?) for the original max rate of 50%.
When the max rate went up to 85%, I think the rationale (excuse?) was that the dollar amounts of benefits generally exceed the dollar amount of taxes that employee and employer paid, so the excess was analogous to interest earnings in a private pension.

But, regardless of the rationale, I agree with your first statement. I just don't see the political muscle to keep giving SS benefits a better tax deal than earned income. Especially since most SS beneficiaries don't understand this.

 

[PatrickA5]

I'm having trouble with your math (or maybe I'm having trouble with my math).

I used this worksheet http://apps.irs.gov/app/vita/content/globalmedia/social_security_benefits_worksheet_1040i.pdf
and assumed our only income was $100,000 of SS benefits.

Line 7 = 50,000
Line 8 = 32,000
Line 9 = 18,000
Line 10 = 12,000
Line 11 = 6,000
Line 12 = 12,000
Line 13 = 6,000
Line 14 = 6,000
Line 15 = 5,100
Line 16 = 11,100
Line 17 = 85,000
Line 18 = 11,100

In this case, 11.1% of the $100,000 SS benefit gets into AGI.

You're correct. I should have plugged some figures in TurboTax. It will take a huge increase in SS payments to hit the 85% figure. Even at $200K of SS, only 25% was taxable.

I think the point I was trying to make is that at some point you won't have to have other income in order to make at least some of your SS be taxable. Of course, when you figure in the standard deduction and exemptions, you'd probably need to have other income to end up actually having a tax liability.

Now that I've actually plugged some scenerios into TurboTax, I guess I will have to continue my quest to reduce the taxability of SS (in the future).

 

[panacea]

I just skimmed this thread, so maybe I missed it... but the calculation for the portion of Social Security that's taxable is a bit more complicated b/c only a portion of the SS benefits themselves actually go into the countable income. Can't remember all the details but I want to say only 50% of the benefits go into the equation. Anyone have more details on this?

 

[pb4uski]

....Both the employee and the employer contribution to SS are "before tax" IIRC. So, to the extent that an individual's SS check results from that contribution, a case will be made that it all should be taxed on "withdrawal" (since it wasn't taxed before it went in). This may be a weak rationale, since the link between contributions and payout isn't very tight, and the "account" isn't owned by the individual, isn't technically a contractual obligation, etc.

If I make a contribution to a deductible IRA then when I later take distributions they are taxable because the contribution reduced my taxable income in the year the contribution was made. Conversely, if the contribution is not deductible, then a portion of the subsequent distributions are not taxable as it is a return to the taxpayer of that non-deductible contribution.

If I earn $100 and pay $7 in SS taxes my taxable income is still $100 so effectively my SS contribution is not deductible. So using the same logic as applied to IRAs I would say the portion of SS benefits that implicitly represent a return employee contribution should not be taxed.

You are right that the employer gets a deduction for their contribution to SS so that is and should be taxable when withdrawn to make up for the fact that it was deductible when paid by the employer.

 

[OAG]

Medicare Premiums (another means tested premium) are deducted from SS benefits but in effect are added back when calculating taxable SS benefits. Currently only sure thing is 15% of gross benefits will be tax free. The rest can be and will be subject to taxation (mostly sooner than later). With all of the potential "pitfalls" tax defense will be geting even more challenging.

 

[ERhoosier]

The "official" history of taxation of SS benefits-
https://www.socialsecurity.gov/history/taxationofbenefits.html

Of course, this "official" history includes some political spin. The long explanation of equal tax treatment of SS & private pensions has, in reality, never been a fairness issue. Back in 1935 when they passed the SS Act Congress knew full well that private pensions were fully taxed and fully intended to have SS benefits not taxed. It was NOT an oversight or misinterpretation as some have claimed, (e.g. Greenspan Commission in '79). Historically, SS benefits levels were set low so the untaxed net purchasing power would be higher. In fact, the IRS ruled in 1941 on that very point stating that SS payments were for "social welfare" and that taxing benefits would be "contrary to the purposes of Social Security". (p 13 in this ref)
https://www.fas.org/sgp/crs/misc/RL32552.pdf

My how things have changed. Now even muni ("tax-exempt") interest is counted as income in figuring threshold for taxation of SS benefits.
https://www.socialsecurity.gov/pubs/EN-05-10035.pdf (p 14)

But NOT for taxation of private pensions.
http://www.irs.gov/taxtopics/tc410.html

When taxation of SS benefits was instituted in '84 it affected only 10% of recipients. When the 85% threshold was added to law in '93 about 18% were affected. Now, according to Soc Sec Admin, about one third of recipient are forced to pay income tax on their SS benefits. And that figure is expected to rise sharply over the next decade since those income thresholds are not inflation-indexed.

 

[Independent]

I just skimmed this thread, so maybe I missed it... but the calculation for the portion of Social Security that's taxable is a bit more complicated b/c only a portion of the SS benefits themselves actually go into the countable income. Can't remember all the details but I want to say only 50% of the benefits go into the equation. Anyone have more details on this?

I linked to a worksheet in post #9. This is the same worksheet that was in the 1040 paper instructions back in the days when most of us got paper forms.

I also have an example in that post.

The law is complex enough that it's hard to describe it in one sentence.

If you have basic excel skills, it's pretty straightforward to code the guts of that worksheet and test various combinations that are relevant to your situation.

 

[samclem]

In fact, the IRS ruled in 1941 on that very point stating that SS payments were for "social welfare" and that taxing benefits would be "contrary to the purposes of Social Security". (p 13 in this ref)
https://www.fas.org/sgp/crs/misc/RL32552.pdf

If social security is viewed as a social welfare program, I'm not seeing why it is inconsistent that those with higher incomes should take home less of it (via a higher effective taxation of the SS benefits--both through a higher %age being subject to taxation and the higher marginal rates that higher income brings).

 

[Animorph]

If social security is viewed as a social welfare program, I'm not seeing why it is inconsistent that those with higher incomes should take home less of it (via a higher effective taxation of the SS benefits--both through a higher %age being subject to taxation and the higher marginal rates that higher income brings).

And via the benefit calculation itself, though the cap on SS employment tax certainly helps a bit.

 

[meierlde]

And via the benefit calculation itself, though the cap on SS employment tax certainly helps a bit.

As well as the decreasing percentage paid as 35 year average monthly income goes up 90% then 33% then 15% Look for SS bend points for details.
For example keeping the current bend points if you raised the limit to a million dollars a year the ss benfit would only go up by 135k a year.

 

[ERhoosier]

If social security is viewed as a social welfare program, I'm not seeing why it is inconsistent that those with higher incomes should take home less of it (via a higher effective taxation of the SS benefits--both through a higher %age being subject to taxation and the higher marginal rates that higher income brings).

Beyond preventing old folk from starving, Congress envisioned a benefit from SS in national morale and unity during the shadow of the Great Depression. SS was deliberately intended to be a strictly egalitarian program. It was argued this would encourage a societal change towards social unity from the unbridled, self-centered capitalism of the roaring '20's. With every identical SS check, each uber-wealthy Rockefeller-type would be reminded that, in the eyes of this Gov't program at least, they were just the same as the poor elderly day laborer. With the Congressional moves in recent years to progressively tax SS benefits, that egalitarian psychosocial side benefit of SS has been lost. (At least as many framers of SS might view it).

 

[athena53]

If social security is viewed as a social welfare program, I'm not seeing why it is inconsistent that those with higher incomes should take home less of it (via a higher effective taxation of the SS benefits--both through a higher %age being subject to taxation and the higher marginal rates that higher income brings).

But that's not how it was "sold". Let's forget for a minute that it's a giant Ponzi scheme and that at the outset citizens were promised that SS numbers would never become a national ID number. It was sold as "insurance" (if you remember when the description on your paycheck was "FICA", that stood for "Federal Insurance Contributions Act"). Now they give you a "benefit" with one hand and take part of it away with the other. DH and I have paid plenty on his SS because up to 2 days ago I was gainfully employed.

And yes, I suspect the "back door" taxation will expand. I haven't looked into it but I'm guessing that any use of Healthcare Spending Account funds for medical or dental expenses, for example, will end up in our Adjusted Gross and thus affect SS. Maybe the same for Roth withdrawals?

 

[F4mandolin]

Is there much of anything that stays as it was "sold" to us? SS.....Iraq......ACA......on and on and on......

 

[REWahoo]

Nothing attracts a pig more than the smell of political comments on the forum...

 

[MichaelB]

Porky Pig Cartoon Ending "That's All Folks!" - YouTube