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The Attack on Your Social Security That's Not Usually Discussed by the Media

June 21, 2012 | Comments: 0 | Views: 164

Hi All, in addition to spending summer having had knee surgery (don't ask!), I'm also spending it studying to take the Enrolled Agent (EA) examination. Since all those who prepare returns for others are required to at least have the Registered Tax Return Preparer (RTRP) designation by the end of 2013, Yours Truly decided he was a glutton for punishment, and decided to take it a step further and attempt the more difficult EA.

One interesting thing I'm learning in my studies is how Social Security distributions are taxed. In discussing the issue with friends, family and clients, not too many are aware of the fact that up to 85% of one's Social Security benefits could be lost through taxation. Most believe that the money is withheld from their paychecks via FICA taxes, along with Medicare, and when they turn 62, 65, 67, or 70, they get ALL of the money they set aside over the years. Uh, no. Not exactly.

Let's take an in depth look at Social Security income taxation. The first thing we need to do is calculate provisional income. The provisional income calculation determines how much of one's social security payout is subject to tax. This is done by taking half of the Social Security benefit payout amount as well as all other income including wages, pension income, investment income (interest and dividends), as well as federally tax free income from municipal bonds, and even income from rental real estate WITHOUT excluding rental real estate expenses. Reduce it by adjustments to income except for tuition and fees deductions, student loan interest deduction and domestic production activities. Once this amount is calculated we will plug that amount in to one of the following formulas to determine how much of your Social Security is subject to tax.

SINGLE, HEAD OF HOUSEHOLD, QUALIFYING WIDOW/WIDOWER-$0-$25,000(Lower Base Amount)-No tax, $25,000-$34000(In between base amounts)-50% max tax, over $34,000(Upper Base Amount)-85% max tax

MARRIED FILING JOINTLY-$0-$32.000(Lower Base Amount)-No tax, $32,000-$44,000(In between base amounts)-50% Max Tax, over $44,000(Upper Base Amount)-85% max tax.

For example if you are a single guy who had provisional income of $40,000, $25,000 would not be subject to tax, the amount between $25,000 and $44,000, around $9000, would get a $4500 tax. Finally, the amount between $34,000-$40,000, around $6000, would get taxed at 85%, or $5100. Add together the $4500 + $5100 to get a tax of $9600. What would happen if the $9600 exceeded the amount of Social Security benefits received? For example, what would happen if you only received, say, $9000? Simply take $9000 times 85% to get $7650. Subtract $7650 from $9000 to get a tax of $1350.

THE REQUIRED MINIMUM DISTRIBUTION (RMD): ADDING INSULT TO INJURY

Now, if you're not steaming mad yet, let me tell you about another trick up their sleeve, the Required Minimum Distributions (RMDs). You see, up until age 70 1/2 you aren't required to take distributions from your 401k or IRAs, heck, you can delay Social Security till 70 too if you really want to. But, after age 701/2 you'll have to collect both Social Security AND take RMDs from qualified plans (401ks and IRAs). Being that RMDs are calculated on a life expectancy formula, and many people can amass quite a fortune in 401ks and IRAs, exceeding the $34,000 or $44,000 mark can be done easily, especially if you have other income from a job or investments. So you get whacked by taking the money out from your retirement plan AND your Social Security can get whacked at 50-85% too. Nice folks up there at the government, huh?

THE MIGHTY ROTH TO THE RESCUE

Luckily, hidden in these gray clouds of taxes is a silver lining, the Roth IRA. The Roth IRA is great because, among its many other benefits, the money you withdraw as a qualified Roth IRA withdrawal (you're over age 59 1/2 AND your Roth IRA has been opened for over 5 years), is NOT included in the provisional income calculation. This allows you to have possibly some small degree of control to keep the provisional income amount as low as possible while still enjoying your retirement funds as tax advantaged as possible. Now this doesn't mean you should go convert your traditional IRAs to Roth IRAs. I'm actually wary of recommending those over 50 convert Traditional IRAs to Roth IRAs. This recommendation needs to be done on a case by case basis as one needs to be able to recover and exceed the amount paid in taxes for the Roth conversion to be worth it, and the performance in the investment markets has been quite rocky the past four or so years. However, anyone who is currently working, and is within the proper income limits, can start a new Roth IRA at any time.

CONCLUSION

This article is far from the be all/end all of retirement planning, but hopefully it gets the "little hamster running in his wheel" in everyone's mind in regards to strategies on how to ensure more of your hard earned dollars end up in your pocket, and not Uncle Sam's. Just make sure this little morsel of information is included in your retirement planning. Good luck, and as always, have a prosperous day.

Christian Halas is owner and wealth manager with Halas Consulting located in Pittsburgh, PA. Halas Consulting prides itself in providing unique and objective solutions to various insurance, investment, banking, tax, and estate issues faced by individuals and small businesses. Investment services provided in conjuction with Venn Wealth and Benefit Services, a PA Registered Investment Advisor. Christian can be reached via email at chalas@venn.us with any questions or comments on this article

Source: EzineArticles
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