Social Security’s Dirty Secret
Dear Rich Lifer,
In a special series last week, I told you what various Democratic candidates have been saying about Social Security – including where they differed on important aspects of the program. (Check it out here)
While doing that research, I came across the following tidbit from Joe Biden’s website:
“Proposals to make the program “means-tested” – so that only low-income retirees workers receive benefits – jeopardizes the program’s universal nature and key role as the bedrock of American retirement. Ultimately, the success of Social Security is largely due to the fact that almost all Americans can rely on the program to make their retirement more secure.”
Well, I agree with the sentiment.
The problem is that Social Security is ALREADY means tested … albeit in a very stealthy way.
Indeed, this is a dirty secret that millions of Boomers – my own parents included – discover the hard way.
Your Social Security benefits themselves can end up subject to income taxes.
Take a step back and think about that.
Your Hard Earned Money Isn’t Safe
You pay into the system through dedicated taxes for several decades…
The whole purpose is funding a program that will eventually make payments back out to you…
Then, when it’s time to finally collect, the government taxes the distributions all over again!
This is absolutely crazy.
Lawmakers love the idea, of course.
Because it allows them to effectively reduce benefits being paid to millions of Americans without having to actually characterize it that way.
And reducing someone’s promised benefits because of how much they earn is means testing. Period.
Now, like Joe Biden, I hope it doesn’t get worse.
But I’m not holding my breath.
Moreover, it is already being done to more and more Americans each and every year.
I suspect many new retirees will be shocked to find this out as they complete their 2019 tax returns.
How the Government Decides to Tax You
Here’s how the current law works:
You could owe federal income taxes on as much as 85% of the Social Security benefits you receive.
It all depends on how much “provisional income” you earn during retirement.
To figure this number out, you add up your adjusted gross income (not including S.S. payments), additional tax-exempt interest you’ll collect, plus half of your S.S. benefits.
If you file a joint return:
- Your benefits are tax free if your provisional income is less than $32,000 …
- No more than half your benefits can be taxed if your provisional income is between $32,000 and $44,000 …
- And if your provisional income exceeds $44,000, it’s almost certain that 85% of your benefits will be taxed.
There are several things to note here:
First, if you file single or head of household, these thresholds go DOWN significantly — i.e. taxation begins at provisional income of $25,000.
Second, in that middle range the actual methodology and exact amounts get tricky but the end result is that you will likely owe a good amount of money back to Uncle Sam.
Third, these thresholds have NOT been getting readjusted for inflation!
I can’t stress the last point enough.
These numbers were originally established back in 1984.
It is now 36 years later and they haven’t been adjusted. And as you know, $32,000 a year isn’t all that much money these days.
So what was initially designed to target a small segment of the population now blankets a large swath.
The lack of inflation adjustment is the primary reason more and more retirees are getting snagged every year.
The Number of People Taxes is Growing… FAST
The Congressional Budget Office said 39%, or 16.9 million, of Social Security beneficiaries had some amount of their benefits taxed back in 2005.
More recent numbers from the IRS and other sources now suggest it’s roughly two-thirds (66%) of all Social Security beneficiaries!
The taxation of Social Security benefits punishes people who have planned adequately for retirement – along with large groups of regular Americans who happen to have pensions or other well-deserved retirement income sources – and only raises more questions about the overall fairness of the current Social Security system.
This is something that hits lots of “regular” Americans – teachers, firefighters, middle managers, assembly line workers, etc.
But again, based on the rapidly deteriorating condition of our nation’s retirement system, and contrary to what some politicians are saying, I think this is just the beginning of a larger trend.
So is there anything you can do to avoid having your Social Security benefits taxed?
You may be able to shift around certain retirement distributions and use certain types of investment accounts to control how much provisional income you receive in any given year.
I would recommend working with a tax advisor or financial planner to figure out what’s right for your particular situation.
But at the very least, be careful how and when you sell stocks, real estate, or other major assets because bad timing could easily cause your benefits to be reduced more than they need to be.
To a richer life,