Social Security tax bites

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In any discussion about putting Social Security on a more even keel, the first suggestion that comes up is usually requiring those people who make more than some threshold to pay more — and, perhaps, get less.

Just for the record, people who earn more in retirement already get less Social Security because they have to pay taxes on their benefits.

Social Security says 34 percent of recipients pay taxes on their Social Security. Whether or not you pay taxes on Social Security is based on what Social Security calls “combined income,” a calculation that is unique to the administration. You take your adjusted gross income on your 1040 federal tax return — line 37 — and add in any tax-exempt interest you receive and half of your Social Security benefits.

If you’re single and your combined income is less than $25,000 or you’re married and your combined income is less than $34,000, you don’t pay anything. If your combined income is between $25,000 and $34,000 for single people or between $34,000 and $44,000 for couples, half your Social Security benefits will be taxable. If you earn more than these thresholds, 85 percent of your benefits are taxable — you never pay on more than 85 percent of your benefit.

The way many moderate-income people reach the level where their benefits are taxable is by hitting age 70 1/2,  when they must take required minimum distributions, or RMDs, from their tax-advantaged retirement savings, including individual retirement accounts.

For example, if you’re getting the maximum benefit at age 66, full retirement age, of $2,513 per month or $30,156 a year, even without cost of living adjustments, when you reach 70 1/2 and face RMDs, you’re likely to be pushed into the 25 percent tax bracket, especially if you’re married and filing jointly — even though you’re not what most people would consider a high-income earner living in the lap of retirement-planning luxury.

While this person is, on paper, entitled to very generous Social Social benefits, the amount of money he’s pocketing is significantly reduced by taxation. In the 15 percent effective tax bracket, as much as $4,534 of Social Security goes back to the federal government, and some states also tax Social Security. Someone in the 25 percent effective tax bracket will pay $7,539 back to the government plus whatever the state tax bite is.

It’s a big leveling factor that would have to be considered in any rejiggering of the plan, especially if those who earn more than the current Social Security cap of $110,600 a year are expected to pay more.