Understanding How Social Security Income Benefits Are Taxed

by ClientFirst on February 24, 2015

in Practice Tips

Understanding how Social Security income benefits are taxed is a topic that is just now gaining attention as Baby Boomers reach age 70. Retirees with IRAs must begin taking Required Minimum Distributions (RMDs) at age 70 ½. This additional income can trigger a significant increase in their tax liability due to the way Social Security income is taxed.

Many retirees are not even aware that up to 85% of their Social Security income benefits can be taxed. They may have planned well for a secure retirement by maximizing their Social Security benefits and saving in IRAs, only to find that when they begin taking RMDs their income taxes take a sharp jump. This is why the tax on Social Security income is often referred to as the “Stealth Tax”.

The good news is that, with some awareness and pre-planning, the taxation of Social Security income benefits can be managed to have a lesser impact on annual income taxes. The 3-part test to determine if and how benefits are taxed seems confusing at first. However, if explained in a simple way with example case studies, the concept can be understood quickly.

Accountants are aware of Social Security income taxation but, as an automatic calculation on their tax software, may not even be exactly sure of how this tax is calculated. They also may not always in the position to know if their clients have IRAs and how much those RDMs will be.

As an advisor, your awareness and knowledge of this topic will make you a valuable resource to retirees and someone to whom CPAs will refer clients to become educated on this topic.

ClientFirst Financial can help you fully understand the affect of Social Security benefits on annual income taxes. Our power point, Smart Ways to Manage Social Security Income Taxes, (available to members only; learn more about membership) shows you how to determine if a client’s benefits will be taxed and how to calculate that amount. We offer a variety of management options for you to consider when advising clients on their retirement financial plan. The affect can be to increase lifetime income and decrease taxes, thereby extending portfolios and standard of living in retirement.

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