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Social Security is a vital source of income for millions of older people, and while you often hear that it is not advisable to live on these benefits alone, the reality is that many older people do. But some people are good at saving for retirement and securing other sources of income. As such, their benefits represent only a portion of their total income for seniors.
It really is a more ideal situation. But older people with an outside income take a big risk: being taxed on their social security benefits. And worse yet, the rules around these taxes haven’t changed for years, and older people often feel the pain.
A set of obsolete guidelines
Seniors who have no income outside of Social Security can usually avoid taxes on their benefits. But those with additional income are often penalized in the form of taxes.
Image source: Getty Images.
The taxation of benefits is based on a calculation called provisional income, that is to say the income of an elderly person outside Social Security increased by half of their annual benefit.
Seniors are taxed on up to 50% of their benefits once their interim income exceeds $ 25,000 for singles and $ 32,000 for married couples. They then have to pay taxes on up to 85% of their benefits once their interim income exceeds $ 34,000 and $ 44,000, respectively.
The problem, however, is that these thresholds have been in place for decades. In 1983, the decision was taken to tax up to 50% of benefits at the above-mentioned levels. In 1993, this rule was changed to tax up to 85% of benefits, also at these same levels.
Meanwhile, the cost of living has increased dramatically since then, but income thresholds for Social Security taxes have not. And that leaves the elderly in a very bad situation.
Avoid taxes on benefits
Seniors who strategically save for retirement can avoid getting taxed on their Social Security benefits. And one of the easiest ways to do this is to save in a Roth IRA.
Roth IRA withdrawals are not taxable income, nor are they counted against provisional income. As such, a single filer who collects $ 18,000 per year in Social Security and also takes $ 24,000 per year in Roth IRA withdrawals would not have to pay benefit taxes despite having total income of 42,000. $ and a provisional income of $ 33,000.
Although high earners are not allowed to contribute directly to a Roth IRA, it is still possible to fund a traditional IRA and then convert it to a Roth account afterwards. It’s a worthwhile decision, given that Roth IRAs offer other benefits in retirement besides helping seniors avoid Social Security taxes. For example, Roth IRAs are the only tax-efficient retirement plan that does not impose minimum required distributions.
It is bad enough that the elderly are taxed on their social security income. But what compounds the problem is the fact that the income thresholds that determine this have not changed for several decades.
There is already pressure on lawmakers to change the way social security increases are calculated. Seasoned lawyers should also consider encouraging lawmakers to review these tax rules.
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