The taxation of Social Security benefits

Karin Price Mueller/The Star-Ledger writes: QUESTION. I have been doing a lot of reading regarding the best way to start drawing Social Security benefits for me and my wife. I understand there are taxes required if you have earned income while collecting Social Security if you reach a certain dollar threshold. I believe earned income comes from working or providing paid services. My wife and I only plan on two sources of funds: Social Security and IRA withdrawals. We are 65 and 64. Our intent is to live off our IRA funds until we each reach full retirement age, and then collect Social Security benefits with my wife exercising her “spousal benefits.” The question: Would our Social Security be taxed if the IRA withdrawals exceed the dollar value threshold?

— JB

ANSWER:  Good for you, JB, for considering these important tax issues before you retire, when it’s probably too late to alter your plans.

Many soon-to-be retirees wonder how Social Security benefits are taxed.

Like most IRS rules, the ones governing this topic are more complicated than we’d like, said Brian Kazanchy, a certified financial planner with RegentAtlantic Capital in Morristown.

“Anywhere from zero percent to 85 percent of your Social Security benefits will be taxed,” Kazanchy said.

He said the base amount to use when calculating the taxability of your benefits is as follows:

• $25,000 if you are single, head of household, or qualifying widow(er)

• $32,000 if you are married filing jointly

He offered a few scenarios to explain.

How IRA income impacts the taxation of Social Security benefits

Scenario 1: If all of your income (pensions, wages, IRA distributions, interest, dividends, other taxable income and tax-exempt interest) plus one-half of your Social Security benefits is less than your base amount of $32,000 for a married couple (or $25,000 for a single tax filer), then none of your Social Security benefits are taxable.

Scenario 2: If all of your income plus one-half of your Social Security benefits are more than $44,000 for a married couple (or $34,000 for a single tax filer), then 85 percent of your Social Security benefits are taxable.

Scenario 3: If all of your income plus one-half of your Social Security benefits are more than $32,000 for a married couple (or $25,000 for a single tax filer), but less than $44,000 for a married couple (or $34,000 for a single tax filer) then 50 to 85 percent of your Social Security benefits are taxable based on a more intricate calculation.

Kazanchy said determining how you can fund your lifestyle with the most tax-efficient combination of IRA distributions and Social Security benefits will be important.

He also recommends you consider a different scenario known as “file and suspend.”

“If the husband files and suspends his benefit, then the benefit will grow 8 percent per year with delayed retirement credits until age 70,” Kazanchy said. “The wife can still collect her spousal benefit at her full retirement age.”

Assuming you have enough IRA assets to help fund your living needs, the 8 percent return on the delayed retirement credits is very attractive.

“Where else can you earn 8 percent per year with no volatility?” he said “In addition, if the husband predeceases the wife, her benefit will step up to the full amount of his Social Security benefit.”

“If he has earned delayed retirement credits, he will be able to leave more income to his wife to fund her living needs,” he said.