In the last issue of Bottom Line Personal (February 1), we looked at some important and tricky questions about Social Security eligibility and options for claiming your benefits.
In this issue, economics professor and Social Security expert Laurence J. Kotlikoff answers important questions about paying taxes on your benefits…and about how your Social Security is affected if you earn money while receiving benefits.
My Social Security benefits will be taxed only if I have a lot of other income during retirement, correct?
Unfortunately, that’s increasingly not the case. When the taxation of Social Security benefits began in 1984, we were told that this would affect only the wealthiest of retirees—and, indeed, in 1984, fewer than 10% of beneficiaries paid federal income tax on any part of their benefits. But there was a trap hidden in these tax rules—the income thresholds that triggered the taxation of benefits did not automatically rise to keep pace with inflation.
Individuals who have a “combined income” (explained below) of just $25,000 to $34,000 must pay income tax on as much as 50% of their Social Security benefits ($32,000 to $44,000 for married couples filing jointly)…and individuals who have a combined income of $34,000 or more must pay income tax on as much as 85% of their benefits ($44,000 or more for married couples filing jointly).
Those thresholds seemed pretty high in 1984, but as of 2015, more than half of beneficiaries exceeded these thresholds and were required to pay taxes on some of their benefits—and that percentage will continue to climb due to inflation. It is not unreasonable to say that the government is setting us all up to pay income tax on 50% to 85% of our Social Security benefits in the future.
Warning: Don’t assume that you will be safe just because you expect your adjusted gross income (AGI) to be below the thresholds cited above. The “combined income” figure that is used to determine Social Security benefit taxation is your adjusted gross income plus any nontaxable interest you received plus half of your Social Security benefits.
My husband recently passed away, and I started receiving survivor’s benefits. My 15-year-old daughter started receiving survivor’s benefits, too. How will her benefits affect my taxes?
They will not affect your taxes at all. Children younger than 18 (younger than 19 if still in high school) often are eligible to receive Social Security benefits if a parent dies or retires. But these children’s benefits are considered taxable income for the child, not for the parent. That’s true even if the child’s benefit checks are made out to the parent.
Your daughter probably will not have to pay taxes on her benefits, either. Social Security benefits are taxable only if the recipient exceeds certain income thresholds, which very few minors do. To make sure, combine one-half of the child’s annual Social Security benefits (do not include your own benefits in this calculation) with all of the child’s other income, including any tax-exempt interest. As long as the total is no greater than $25,000 in a given year, no part of the child’s Social Security benefits is taxable.
I recently returned to the workforce at age 68, and I am making more money now than I did during the early years of my career. I’m already receiving my Social Security retirement benefits—but will my future benefit checks increase because of the additional income I am now earning?
Your retirement benefits are based on your highest 35 years of inflation-adjusted earnings. These 35 years can be recalculated even after you have started receiving your benefits, so, yes, if you earn more on an inflation-adjusted basis this year than you did in your thirty-fifth-best earnings year, your benefit checks should increase slightly. Unfortunately, the Social Security Administration can be slow in recalculating benefits in these cases—but when it does get around to it, you will be paid retroactively any money that you are owed. If you want to speed along this process, you can visit a Social Security office in person and request a manual recalculation of your benefits. Bring your W-2 forms or other proof of your recent income.
There is a downside to earning significant income while receiving Social Security retirement benefits—the income might mean that as much as 85% of your benefits are subject to federal income tax. Don’t let this stop you from working, however, because the income you earn will more than make up for any extra taxes.
I intend to retire in the middle of this year, at age 64—even though I know that I’m not at full retirement age—and I’d like to start my Social Security benefits as soon as I retire. But if I earn a significant amount of income during the first half of this year (before I retire), will I exceed Social Security’s annual earnings limits and lose a lot of my benefits for the rest of the year?
Not necessarily. It’s true that Social Security has an “earnings test” that, as of 2017, can reduce recipients’ benefits by $1 for every $2 earned in excess of $16,920. (This earnings test applies to recipients who have not yet reached their “full retirement age” year, as you have not. Different earnings test rules apply during the calendar year in which you reach your full retirement age. There is no earnings test after the year in which you reach your full retirement age.)
But there also is an alternative monthly earnings test that you can opt to use in the first year that you receive Social Security benefits. Under this monthly test, your benefits will not be reduced during any month in which you earn less than $1,410, which is one-twelfth of the $16,920 annual limit. (You also must not “perform substantial services in self-employment” during these months. See the publication How Work Affects Your Benefits at SSA.gov for additional details.)
Thanks to this alternative monthly earnings test, you could, for example, earn $8,000 per month from January through June, then retire, start your benefits in July and not have any of your benefits withheld even though the $48,000 you earned during the first half of the year easily exceeds the $16,920 annual earnings test.
There is one common misconception that’s worth clearing up about the “earnings test.” Many people believe that if they do have benefits withheld because of earnings, they have lost that money forever. That is not true.
Future benefits are adjusted upward starting at your full-retirement age to compensate you for any benefits that you did not receive previously because of the earnings test. Of course, if you switch to a different benefit at or after full retirement, such as a widow(er) benefit, this adjustment will be of no real value.
If you have a Social Security question of general interest, send it to our personal finance editor at BLPersonal@BottomLineInc.com. It may be answered in a future issue.
How Social Security Feasts on Your Paycheck
The Social Security tax rate has not gone up in many years—but that doesn’t mean your Social Security taxes haven’t grown. The government has been using a sneaky, backdoor way to dramatically increase Social Security taxes and take a bigger bite out of many workers’ income.
Although the Social Security tax rate has stayed more or less steady since 1990 (the only exception was a temporary reduction in 2011 and 2012)—at 6.2% of wages from employees (and the same from employers)—the amount of earnings that is subject to this tax rate each year has jumped from $65,400 in 1997…to $97,500 in 2007…to $127,200 in 2017. Those increases are well above the overall rate of inflation—in fact, the jump in earnings subject to taxation for 2017 alone is 7.3%, far higher than the recent inflation rate of less than 2%.
Result: If you earn $127,200 or more this year in Social Security–covered employment, you and your employer will each have to pay $539 more than last year in Social Security tax.