SOCIAL SECURITY TAX TRAPS – TAX OPPORTUNITIES

SOCIAL SECURITY TAX TRAPS – TAX OPPORTUNITIES

By: John Rother and Evelyn Morton

The long arm of the Social Security Administration touches almost all of us at some time in our lifetimes. But getting straight answers from the 63,000 person bureaucracy is daunting. Its complex rules and regulations can easily reduce some of the benefits to which you are entitled. Important advice to maximize benefits:

* Beware of “early” retirement. Even though the statistics show that most people retire now by about age 62, the “normal” age for retirement as far as Social Security is concerned is 65. For every month you retire before your 65th birthday, your Social Security benefits will be reduced by 5/9ths of l%. That works out to a 20% reduction in benefits for someone who retires at age 62.

Bigger problem: Because of the continuing increase in longevity, particularly among women, most people fail to anticipate the long-term impact that inflation will have on their savings.

What seems like an adequate retirement income at age 62 – income from a company pension and accumulated investments, as well as Social Security payments – may seem woefully inadequate 10 years later, when prices may have risen by more than 50%. Even more worrisome is the cost of health care, which has been growing at two to three times the general rate of inflation and is a major component of most older people’s budgets.

If you retire today at the age of 62, you can expect to live another 20 to 25 years. Therefore, you should be thinking now about whether or not there will be enough in your retirement pot to support you in your seventies and eighties. Most middle-class people should have more than a pension and Social Security check.

* It may pay to work past age 65. For every year you delay retiring, your annual benefits will be increased by a percentage that varies according to the year you were born. This is no free-lunch from the government. The higher benefits are to compensate for the fact that, in all likelihood, you’ll be receiving benefits for a shorter period of time than if you had retired at age 65.

* Avoid the earning-too-much-in-retirement trap. If you can’t continue working full-time once you turn 65, you may want to establish a part-time arrangement with your old company. But be careful not to earn too much. Retirees aged 62-64 can earn up to $7,440 without lowering their Social Security benefits. However, they’ll lose $1 in benefits for every $2 they earn above that level. The rules are a bit more liberal for retirees aged 65-69 who can earn up to $10,200 a year without any cut in benefits. They’ll lose $1 in benefits for every $3 they earn above that level. Retirees aged 70 and older can earn as much as they like without any cut in benefits.

But if you’re self-employed-in your own consulting business, for example, the rules are different. In some cases, they’re looking at the number of hours you work. They want to see how involved you are in the company. It’s a gray area in which the Social Security Administration may demand documentation regarding the extent of your involvement in the business. Be prepared to answer a lot of questions.

* Be aware that tax-exempt income doesn’t relieve you of being taxed on your benefits. If your income is above a certain level and much of it is derived from tax-free municipal bonds, you may find that up to half of your Social Security benefits will become subject to income tax.

To determine whether some of your benefits will become taxable: Determine your Adjusted Gross Income (your taxable income from pensions, interest and dividends minus payments for such items as alimony).

Then, add to that figure your income from tax-exempt municipal bonds and income from foreign securities. If the resulting figure exceeds $32,000 for couples ($25,000 for singles) – part of your Social Security benefits will be taxable.

When Congress enacted this law back in 1983, it was intended to catch – the wealthiest of retirees. At that point, only about 5% of beneficiaries were required to pay tax on some of their Social Security benefits. But the income threshold level has not been indexed to keep pace with inflation.

Result: More and more retirees are finding that part of their benefits are now taxable. At the end of 1991, nearly 20% of beneficiaries were subject to tax on their benefits.

Benefit trap for workers in the public sector before joining the Social Security system: Social Security was designed to give low-income workers a greater proportion of their pre-retirement income in benefits than high-income workers. Several years ago, Congress enacted a law to reduce “windfall benefits” for former government employees who, on paper, appeared to be low-income workers.

These people were eligible for special government pensions because they spent most of their career in the public sector. They then “retired” and took jobs in the private sector, where they also became eligible for Social Security benefits. To prevent these people from reaping dual benefits, Congress decreed that they faced a benefit cut unless they worked for companies that participated in the Social Security system for at least 21 years. Maximum benefit cut: 40%

* Register for Medicare before you turn 65. Even if you don’t plan to use the health care coverage right away, you may face a penalty – in the form of a higher premium – if you fail to register by the deadline.

 

(The above material appeared in Tax Hotline.)

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