Is Social Security Taxable? Yes, Especially For Widows!

In part three of our series on “Why You Need a Roth” we break down the required minimum distributions (RMD) that Bob and Jane will have.

Now they are 70 years old. Each has $1 million in their deferred accounts. RMD factor for year 1 is you divided that $1 million by 27.4 to get your amount.

Now though, because Bob and Jane decided to go more conservative with their portfolio and only expect a rate of return of 5%, we SUBTRACT this years RMD amount from last years ending balance and times by 1.05 to give us THIS YEARS ending balance.

Then we take that amount, divide by 26.5 which is the RMD requirement and do the same thing.

Next year we take the ending balance divide by 25.6 and so on.

However, when Bob dies and leaves Jane with his IRA, Jane’s RMDs do not change. She will be under the same schedule as previously, because they are the same age, BUT, and this is HUGE, she’ll have MUCH higher income tax to pay.

She is no longer a married filing jointly taxpayer. She is a single taxpayer going forward. And her taxes grow, and grow each and every year even though her income declines significantly.

So, what’s the solution? Stay tuned…

Social Security taxation is one of my all-time pet peeves. Primarily this annoys me because by the time the taxes are felt, it’s too late for the taxpayer to do anything about it.

At that point, it’s just a matter of hoping they have enough resources to pay the tax-man and live comfortably.

Tax-Exempt Interest Affects Social Security Taxation

In the video below, I show you an article from Money magazine where in passing a tax pro mentioned how tax-exempt benefits are taxed when it comes to your Social Security.

Unfortunately, this mention was made in passing and I imagine most people would overlook it.

He said that tax-exempt interest is counted in your combined income to determine the amount of taxes you pay on Social Security.

Don’t Overlook This!

But the writer of the article completely failed to discuss in any further detail, as is typical with business writers. They seem to over-look what should be obvious and thus fail to ask the fundamental question “You mean to tell me my tax-exempt interest can make my Social Security subject to taxation?”

Doesn’t that seem odd? That tax-exempt interest is part of the calculation for determining taxes on Social Security?

When Tax-Exempt Is NOT Tax-Exempt

Of course it does! Tax-exempt is “Tax Exempt”, after all. But it’s not!

Why the financial media and other financial professionals don’t understand this boggles my mind.

But it gets worse!

Married or Single Is a BIG DEAL

How Social Security is taxed is also contingent on if you’re married or single.

A single person with $34k of Social Security benefits and $20k of other income, pays $1616 in Federal Income tax.

A married couple with $40k of Social Security and $20k of other income pays NOTHING in Federal Income tax. Yes, you heard that correct – NOTHING!

How Single Taxpayer Pays More in Tax on LESS Income

The single person had gross income of $54k and paid nearly $2k in taxes.

The married couple had gross income of $60 and paid nothing.

In fact for the married couple to pay the same amount of tax as that single person they’d need a whole lot more gross income.

Watch my video on this exact topic.

Don’t Wait To Plan!

But here’s the problem; What are YOU doing about future taxes, now? Is your tax software helping you understand the tax trap that awaits? Your financial advisor? Your accountant?

I doubt it. What most tax planning does is account for where you are today, without giving much a thought to what your circumstances will be in the future.

Then, it’s too late. When you’re an 80-year-old widow with a tax bill of $10k there isn’t much you can do. You pay the tax man, or they come after you.

So, plan now!

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