I do tax preparation, tax planning and tax representation, as was as investment advisory for clients primarily in Western Pennsylvania as well as other areas of the state and country.
If I had a dollar bill for every recent retiree that got socked with an unexpected tax bill in retirement, I'd be significantly wealthier. Why is this? Well, it's mainly because most fail to figure in their Social Security proceeds in with their tax planning, and even when they do figure it in, fail to realize how much of it is subject to taxes.
Originally, Social Security income was not subject to income tax. This "party" ended in 1983, when amendments to the National Social Security Act subjected Social Security income to tax beginning in 1984. In that first incarnation of taxation, 50% of Social Security benefits were subject to tax for those with and Adjusted Gross Income (AGI) of $25,000 if single, or $32,000 if married. The tax proceeds were to be deposited into the OASDI (The formal name for Social Security, an acronym of Old Age Survivor and Disability Income) Trust Fund and not the general treasury.
In 1993 the formula for taxation of Social Security was changed. Thresholds for different incomes were added or changed in order to tax higher income individuals to a greater degree. The new high-end thresholds were $34,000 for individuals and $44,000 for married filing jointly and $0 for Married Filing Separately (ALL of their income gets whacked at 85%. Talk about an incentive to get that late in life divorce done quickly!) The difference between the 50%, discussed previously, and the new 85% were to be put in a separate HI (High Income) Trust Fund. (Note: This is an extremely condensed version of the Social Security "story" if you want to read about it more in depth, you can do so at Social Security History (ssa.gov))
This whopping 85% is what throws people for a loop because those $34,000 and $44,000 thresholds for both singles and marrieds hasn't been changed since 1993, and with the stock market surges since that time, most people's 401k/403b/IRA balances are through the roof. Even worse, even if these folks and their financial and tax advisors do some advanced planning, they can only hold off the tax "beast" for a limited time because the RMD requirements kick in during one's early to mid 70s, as does the late Social Security election, and that almost assures those thresholds are quickly left in the dust.
Let's look at a brief example, if a husband and wife filing jointly each take a modest $2000 per month from their retirement accounts, which totals $48,000 ($24,000 each) that already puts them over the $44,000 threshold of married filing joint couples. Now let's figure they both receive an equal amount in Social Security distributions. Of that $48,000 in Social Security distributions, a whopping $40,800 would be included in income! Many retired folks have a lot more than that in a given year. Now, also figure that unlike 401k and IRA distributions, most people DO NOT have withholding taken from their Social Security distributions, this is the default actually. One has to actively request withholding of taxes from Social Security, similar to IRA and 401k distributions. Unfortunately, many folks who DO have withholding taken from their IRA and 401k distributions, DON'T request withholding from their Social Security. I also didn't get into the STATES that tax Social Security to some extent (13 of them do, 13 States That Can Tax Your Social Security Benefits | The Motley Fool).
I think it's plain to see how many retired people are not happy campers at tax time.
Halas Consulting
Ph: 412-685-4285
email: chalas@vennwealth.com
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