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Dont Get Blindsided by the Social Security Tax Torpedo.

By: Paul C. Spoelstra CFP, AIF a CERTIFIED FINANCIAL PLANNER, practitioner with Milestone Wealth Management

So you are coasting along toward retirement, focused on the last few years of your career and still believing that Social Security is tax free and doesnt require any tax planning.

Think again.

Most retirees are shocked to learn that Social Security can impact their taxes and they are typically informed thatare told there is nothing they can do about it. What makes the sting even worse is after you have faithfully invested into your 401(k) or other retirement plans you discover that its those funds that can dramatically impact the Tax Torpedo. By getting yourself acquainted now with some basic facts about Social Security, its impact on the tax return, and how to implement a simple strategy, you can avoid being hit by the Tax Torpedo.

History of Social Security Taxation

Lets start off with a little history. After many of his predecessors added promises and legislation to strengthen Social Security, President Ronald W. Reagan and the democratic controlled Congress in 1984 set in motion in 1984 a tiered system of Social Security taxation. Ten years later, President William J. Clinton and a split Congress added an additional tier of 85% to the law. Currently there is not a direct tax on Social Security, but other income can force certain percentages of Social Security income into the taxable column of ones 1040 return1.

How does the Tiered Taxation System Work?

Legislation in 1984 and 1994 has left us with a tiered taxation system that simply creates an additional tax burden for those with higher incomes. Once a low income threshold is met ($25,000 for single taxpayers and $32,000 for filing married), every dollar received from other income (i.e., IRAs, 401(k)s), can cause up to 50% of a retirees Social Security income to become taxable. The real sting begins when

the thresholds bump up just a little, so 85% of the Social Security income is taxed! That is a big chunk! (The higher thresholds are $34,000 for singles; $44,000 for married.)

A New Strategy to Control the Tax Torpedo

It is critical that you implement an income strategy as early as you can when you are in the Social Security income age. The earlier you implement this strategy the better your bottom line can become. If you are already drawing Social Security income dont be discouraged, as there are two points in time when you can change your income and begin to leverage this strategy. More on those later.

The strategy is simple; real simple. Just delay your Social Security income, as long as you can between the ages of 62 and 70, and then construct a retirement income plan that fits your expense needs. This could require you to dip into your tax deferred investments, yet with a well laid out plan you can see the financial impact of avoiding the Tax Torpedo during these critical years. Lets take a look at an example:

IRA income Tax Rate IRA Tax (A) x =

$1 25% .25

Additional Social Security subject to tax % of Social Security income subject to tax Taxable Social Security income x




Tax Rate Social Security tax (B)

x =

25% .2125

Total tax in cents (A + B) Total tax in percentage:


OR 46.25%

The impact on the bottom line can be dramatic when a thorough analysis is performed. Thus, when comparing the impact of the Social Security tax it becomes apparent that a well thought out plan can add serious net income to the bottom line. Research provided by Prudential Investments has found that many individuals, with after-tax income up to the mid $90,000 range, can see significant tax savings from delaying Social Security2.

More Social Security Rules that Can Further Leverage This Strategy

1) While you delay your Social Security payments, the future payments that you will receive can grow up to 8% annually. For those that are seeking to invest their IRA or 401(k) conservatively, this is a potentially difficult return to beat in todays investment environment. 2) If the Social Security recipient is married, the delay can bring an ever increasing survivor income to the spouse. Life expectancies are getting longer, especially when analyzing the life expectancy of a married couple. 3) By taking off the growth pressure from the IRA or 401(k), a reduced Required Minimum Distribution (RMD) for those post 70 years can help minimize the Tax Torpedo when you start to receive Social Security at age 70. For the more aggressive investor, an additional 7 years of deferral can add $10s of thousands on top of an already bloated RMD.

What If One Changes Their Mind?

The Social Security Administration recognizes that recipients change their mind; however, they have limited choices if they want to change. If they have been taking their benefit for less than 12 months, they can complete a simple form and send back all the money received; this puts them back to as if they never took the benefit. This is usually used for those between the ages of 62 and full retirement age (FRA).

If a recipient is at or over FRA they can simply stop their Social Security income, which immediately begins to correct the impact of the Tax Torpedo. To add an extra flair to it, the income would then to grow at the 8% annual rate until the income started once again. (Make sure that Medicare premium is properly paid during this new time of deferral.)

A Gentle, Yyet Firm Reminder

The strategy of delaying your Social Security income can be a difficult one. For decades you might have been told to take it as early as possible. This new strategy must be weighed carefully against your personal or family history of life expectancy. Even when the benefit of a growing survivorship income is factored in, these ideas work best when you and your spouse are able to enjoy a long and fruitful life.

Making a decision on Social Security is more complicated than it first seems. After years of saving and investing, a personalized retirement income plan can add many dollars to your bottom line. Take control of Social Security, while you still can.

A consultation with a professional tax advisor, financial professional or an attorney is suggested to adequately evaluate the impact of social security on ones income.

Innovative Strategies to Help Maximize Social Security Benefit Prudential Investments (2/01/2013)

Paul C. Spoelstra CFP, AIF is a CERTIFIED FINANCIAL PLANNER, practitioner with Milestone Wealth Management serving West Michigans individuals, corporations and municipalities since 1994. Paul speaks often on Maximizing Social Security and can be reached at 616-642-9595 or to schedule either a private consultation or public event.

Securities and advisory services offered through Commonwealth Financial Network, Member FINRA/SIPC, a Registered Investment Advisor. Milestone Wealth Management, 1345 Monroe Ave NW; Grand Rapids, MI 49505