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Preventing Social Security Income from Becoming Taxable
Social Security Benefits are taxed using a computation called provisional income. Provisional income is determined by computing your adjusted gross income (AGI) and adding to it one half of your Social Security total benefits. Social Security benefits are documented on Form SSA-1099 or RRB-1099 (railroad retirement benefits) and sent to you from the Social Security Administration at the end of the year. Your AGI is formulated on your tax return.
Let’s look at an example:
- Jack and Jill have a combined taxable investment income (income from dividends, interest or capital gains) of $16,000.
- They also have a tax exempt interest (municipal bonds) of $13,000.
- Together they receive Social Security benefits of $20,000.
- Their modified AGI ($16,000 + $13,000) is $29,000.
- This number is added to ½ the value of their Social Security benefits ($10,000) for a total of $39,000($29,000 +$10,000) provisional income.
Tax deferred annuities are not counted as taxable investment income (line 1) or tax exempt interest (line 2). They are a tax deferred financial product. Taxes are only incurred when a payment is made to you and only the interest (not the principal) is considered taxable income. Hence Annuities are helpful in reducing the amount of Social Security benefits to be taxed. Note that even though the Bond income in this example was tax free, it is still counted in the provisional income calculation.
For a married taxpayer, if provisional income is less than $32,000, Social Security benefits are not taxed. If married filing jointly with provisional income in the range of $32,000 – $44,000 subjects, 50% of Social Security benefits are taxed. If your combined provisional income exceeds $44,000, 85% of your Social Security benefits are subject to taxation.
For a single taxpayer, if the provisional income is under $25,000 no Social Security benefits are taxable. When filing as a single person provisional income in the range $25,000- $34,000 subjects 50% of Social Security benefits to taxation and over $34,000 in provisional income will subject 85% of Social Security benefits to taxation.
There are many people paying taxes on CD interest that they do not even utilize. Deferring that interest not only lowers your taxes, but does not subject those earnings to the Social Security provisional income calculation.