Copywright – 2011 Rajiv Nagaich
The question of tax on social security impacts all 35 million plus retirees who receive social security checks.[1] As of November 2009, seventy percent (70%) of Americans receiving some sort of Social Security benefit were over the age of sixty five (65), with the average monthly benefit to a retired worker being $1,163.60.[2] Sixty Five percentage (65%) of these elderly rely on Social Security for over half their income. One-third (33%) rely on Social Security for over 90% of their income. Nationally, the median married couple or individual recipient age 65 and over relies on Social Security for 67% of income.[3] This means that most retirees will not have the income to be required to file a tax return. That said, there are situations under which social security benefits will be taxable. The rules are quite straightforward. Taxability will depend on the total income of the taxpayer. Either the benefits are not taxable at all, fifty percent of the benefits are taxable or eight five percent of the benefits are taxable.
How are Social Security benefits taxed? Under current law, up to 85 percent of Social Security benefits maybe subject to federal income tax, depending on the taxpayer’s income calculated by making certain modifications. The modifications necessarily start by taking half of the social security benefits the taxpayer receives and adds to this amount the following:
- Taxable pensions, wages, interest, dividends, and other taxable income
- Tax exempt income[4], and
- Excluded income[5]
For taxpayers with modified income (as calculated above) at or below $25,000 for a single individual and $32,000 for a married couple, none of the social security benefits will be taxable.
For single taxpayers with incomes between $25,000 and $34,000 and married taxpayers with incomes between $32,000 and $44,000, up to 50 percent of Social Security benefits may be subject to tax.
For single taxpayers with incomes over $34,000 and for married taxpayers with incomes over $44,000, up to 85 percent of Social Security benefits maybe included in taxable income.
Example. The average monthly benefit as of November 30, 2009, for couples both receiving benefits is $1,876. This works out to $22,512 per year for a retired couple at the average benefit level. For single recipients the average monthly benefit is $1,112 or $13,344 annually. To determine the amount of taxable Social Security Income one would begin with determining the modified income discussed above. That calculation will begin with taking half of the social security income, which is $11,256 for a married couple filing jointly and $6,672 for a single taxpayer. To this other income would be added. The following table shows modified income levels at which Social Security would be fully exempt, subject to inclusion in taxable income at the 50 percent rate, and subject to inclusion in taxable income at the 85 percent rate for a hypothetical married couple filing a joint return and a single taxpayer with the average level of benefits listed above.
| Taxation of Social Security Benefits, Tax Year 2010 | ||
| Retired married couple | Retired single worker | |
| Social Security exempt | Total income less than $43,256 | Total income less than $31,672 |
| Social Security included in taxable income at 50% rate | Total income between $43,256 and $55,256 | Total income between $31,672 and $40,672 |
| Social Security included in taxable income at 85% rate | Total income between $55,256 and $70,709 | Total income between $40,672 and $48,772 |
| Social Security subject to full 85% inclusion in taxable income | Total income over $70,709 | Total income over $48,722 |
The table shows that a married couple that receives the average Social Security benefit of $22,152 and has total income from all sources of less than $43,256 is not subject to tax on any Social Security benefits, while a couple with average benefits and total income over $70,709 must include 85 percent of the Social Security, or $19,135, in taxable income. Social Security income included in taxable income is taxed at the same rate as other kinds of income—5.35 percent, 7.05 percent, or 7.85 percent, depending on the total amount of taxable income.[6]
AT WHAT AGE IS STARTING SOCIAL SECURITY OPTIMAL?
The average retirement age in the United States by the Bureau of Labor Statistics in 2007 is around 62.[7] This coincides neatly with the early retirement age at which a qualified taxpayer can start withdrawing social security benefits. However, just because one can start the benefits does not mean that it is a good idea.
To begin with, early retirement benefits are subject to earned income limitations. Simply put, if a taxpayer continues to work before reaching full retirement age, discussed below, there is a penalty that is assessed which penalty works to lower the amount of the benefits the taxpayer will see. Here is how it works:
- Social Security benefits will be reduced by $1 for every $2 the taxpayer earns above the annual limit ($14,160 for 2010).
- In the year the taxpayer will reach full retirement age, the benefits are reduced by $1 for every $3 a taxpayer earns above $37,680 in 2010, but Social Security only counts earnings before the month the taxpayer reaches full retirement age.
- There is no penalty for income earned after a taxpayer reaches full retirement age.
Next, early benefits are a permanent reduction in benefits. As we are living longer, lower benefits in later years may prove to be a bigger hardship that one would anticipate. Social Security does permit a taxpayer to refund Social Security all the money the taxpayer has received and reset the benefit amount, but this requires payment of a lump sum of money which minimizes the benefit to be achieved.
Finally, much has been documented about the health benefits of working longer or at least staying active after retiring.
For those who are more inclined to view the issue from a purely financial aspect, here are some guidelines that have been proposed by the Center for Retirement Research at Boston College. The authors of a study conclude that married women should take social security early, married men and single women should delay the benefits.[8] The recommendations are primarily based on the fact that married women can claim a higher benefit later based on the spouse’s higher retirement amount and therefore, claiming the benefit early would be appropriate. For those turning 62 between 2005 and 2016, benefits at 62 will be 75% of benefits at 66. Benefits at 70 will be 132% of benefits at 66. Altogether, your benefits will rise a whopping 76% in the eight years from 62 to 70. That’s a compound growth rate of 7.32%.[9] This is a good way for most taxpayers not wanting to risk their portfolio to the market forces to assure a decent rate of return. Alicia Munnell and Mauricio Soto go so far as to determine the optimal age for married women to start Social Security benefits to be 62, married men to be 69 and though no age was suggested for single women as the optimal age, the authors remark that later benefits will be appropriate for single women.
[1] Monthly Statistical Snapshot, November 2009, U.S. Social Security Administration, Office of Retirement and Disability Policy, November 2009, http://retirement.gov/policy/docs/quickfacts/stat_snapshot/index.html.
[2] Id.
[3] Chapman & Ettlinger, Social Security and the income of the elderly, Economic Policy Institute, Research and ideas for Shared Prosperity, April 4, 2005. http://www.epi.org/publications/entry/ib206/.
[4] Such as income on municipal bonds.
[5] Interest from qualified U.S. savings bonds, Employer-provided adoption benefits, Foreign earned income or foreign housing, or Income earned by bona fide residents of American Samoa or Puerto Rico.
[6] Taxation of Social Security Benefits, Minnesota House of Representatives, House Research, http://www.house.leg.state.mn.us/hrd/issinfo/sstaxes.htm
[7] What is the average retirement age in the U.S., Wikipedia, http://wiki.answers.com/Q/What_is_the_average_retirement_age_in_the_US.
[8] Alicia H. Munnell and Mauricio Soto, Why do Women Claim Social Security Benefits so Early?, An Issue Brief, Center for Retirement Research at Boston College, October 2005, No. 35, http://crr.bc.edu/images/stories/Briefs/ib_35.pdf?phpMyAdmin=43ac483c4de9t51d9eb41
[9] Scott Burns, The Best Age to Retire, MSN Money, http://moneycentral.msn.com/content/Retirementandwills/Createaplan/P143306.asp.
