There are lots of advisors out there holding luncheons, steak dinners and seminars trying to scare seniors into giving them their numbers, so they can provide them with a “Social Security report” or “filing strategy.” This is a marketing ploy to get more clients.
You are tantalized with the thought of missing out on hundreds of thousands of dollars in Social Security benefits at these informational meetings. Their premise requires one key thing to happen – you must live to 95 or longer. The shorter your lifespan, the less of a gap created by different filing strategies.
So, what two words should we be talking about in regards to Social Security? Provisional income. I have to be honest, when I first heard this term I wasn’t quite sure what it was, so let’s define it.
Provisional income is a measure used by the IRS to determine whether or not recipients of Social Security are required to pay taxes on their benefits. Provisional income is calculated by adding up a recipient’s gross income, tax-free interest, and 50% of their Social Security benefits.
So why is provisional income so important? It’s important because it determines the tax rate at which your Social Security benefits will be taxed. Let’s look at an example.
Three steps for calculating provisional income
- Start with your gross income, which is the total amount of money you make, not including your Social Security benefits. You can find this amount on your tax return.
- Add any tax-free interest you received, such as interest from a municipal bond, which is always tax-exempt at the federal level.
- Calculate 50% of your Social Security benefit and add that amount to your previous total.
Let’s say your gross income is $20,000 and you earned $2,000 in municipal bond interest. Add those amounts together to arrive at $22,000. Now let’s assume you receive $24,000 in Social Security benefits. Divide that in half to arrive at $12,000. Add $22,000 and $12,000 and your provisional income is $34,000.
How provisional income affects taxation
Your provisional income and your tax filing status decide whether, and how much, your Social Security benefits are taxed:
|Tax Filing Status||Provisional Income||Social Security Taxation|
|Single or head of household||Less than $25,000||0%|
|$25,000 – $34,000||Up to 50%|
|More than $34,000||Up to 85%|
|Joint filers||Less than $32,000||0%|
|$32,000 – $44,000||Up to 50%|
|More than $44,000||Up to 85%|
Seems pretty straight forward, but look at the history of the government and how they change the rules on Social Security. The Social Security Act of 1935 established that Social Security benefits would start at age 65. In 1956, Eisenhower signed an amendment allowing early retirement for women at age 62. In 1961, Kennedy signed an amendment allowing early retirement for men at age 62. In 1983, Reagan signed an amendment stretching out full retirement age to 67, and taxed 50% of benefits. In 1993, Clinton signed an amendment adding an additional 85% taxation of benefits. In 2015, Obama signed an act reducing the number of different filing options.
What’s next? Raise Social Security tax ceiling, 100% tax of benefits, later start, and phase out benefits for higher earners through means testing? Finally, my favorite, raising the Medicare charges since the government withholds those from your Social Security payment before you are paid out.
With 10,000 people a day turning 65 for the next 18 years, I would bet these two words are going to garner more and more attention.
If you want help modeling your provisional income, creating different income strategies to delay your Social Security filing and maximizing your wealth and future income, please contact us here.