By Larry Kotlikoff
April 15, also known as Tax Day, is the deadline to file federal income tax returns to the IRS. Paul Solman asks Social Security expert Larry Kotlikoff about whether or not Social Security benefits are taxed equitably. Photo by Li Kim Goh/Getty Images
Paul Solman — Boston, Mass.: As April 15 is the deadline to file income tax returns, would you mind telling me (and your other readers) how the IRS and state governments tax Social Security benefits?
Is there a “means test” that penalizes higher income earners? Is there likely to be one? If there were, would it make a dent in the huge unfunded liability you have been screaming about for years?
Larry Kotlikoff: Happy dreaded tax day! Were we living in virtually any other country, paying our taxes would be straightforward. But our tax code is as complex, convoluted and confusing as it gets, forcing tens of millions of people like you and me to spend days collecting all the information needed to pay our taxes and then filling out work sheet after work sheet to complete the 1040 form.
Whether we support big or small government, none of us want horribly inefficient government, which is what our tax-transfer system represents.
Now that I’ve gotten this off my chest, let me tell you about one of the worst — and I mean worst — provisions in the federal tax law: the taxation of Social Security benefits. I’m not complaining about taxing the benefits, per se; rather, the simply insane and egregiously unfair way in which it’s done.
The taxation of our Social Security benefits is so complicated that it, in effect, requires its own tax return, as the 30-page, single-spaced instructions form with its 4 worksheets makes clear.
I’ve reverted to ranting again. Sorry, I’ll now stick to the facts.
First, Social Security benefits are subject to federal income taxation if a modified measure of our pre-tax income, called adjusted gross income (AGI) exceeds a certain threshold. Modified AGI (MAGI) includes half your Social Security benefits. If MAGI exceeds these lower thresholds — $25,000 for singles and $32,000 for marrieds, but is below these upper thresholds — $34,000 for singles and $44,000 for marrieds, up to half of your benefits will be subject to federal income taxation. But if your MAGI exceeds the relevant upper threshold, up to 85 percent of your benefits will be taxed.
Whereas virtually all other provisions of the federal income tax are indexed to inflation, these thresholds are not. Hence, over time, as Social Security benefits are adjusted for inflation, you can find yourself paying taxes on more and more of your benefits. Moreover, all our kids can expect to pay taxes on 85 percent of their benefits due to this form of bracket creep. And this will be true even if our kids’ incomes in retirement consist solely of their Social Security benefits.
As for state income taxation of Social Security benefits, there is no single answer. Some states don’t tax them because they don’t have an income tax. Others exempt them from taxation. Others provide partial exemptions.
The bottom line — the Social Security benefit taxation craziness can extend across state borders, so you need to see how your state treats your benefits before the clock strikes midnight!
Tim Hager — Valley City, N.D.: I plan to retire at 67 when my wife will be 65, qualifying both of us for Medicare. I don’t plan to take Social Security until I reach 67. At this time and with the low return on investments, I will not have enough money per month to wait until 70 to start withdrawing Social Security. Any advice regarding my plan and my situation?
Thanks in advance for your help. Your articles are very helpful in understanding Social Security.
Larry Kotlikoff: You don’t need your wife to qualify you for Medicare. If you are currently over 65, you are eligible right now for Medicare.
The Social Security Administration’s own literature makes this clear. You don’t need to be taking Social Security to be eligible to receive Medicare. If you start Social Security retirement benefits at 67, your wife can start taking an excess spousal benefit at 65 or wait until her full retirement age, 66, to start collecting her full spousal benefit.
If she makes it to full retirement age without filing for her own retirement benefit, she can apply just for her full spousal benefit and defer until 70 collecting her own retirement benefit. What is optimal depends on the specifics of your earnings records.
Richard Davis — Romeo, Mich.: I am 74. I have been a house husband most of my life. I have been told I have 30 points and need 40 to collect benefits. Am I entitled to any?
Larry Kotlikoff: You likely can collect spousal benefits on your current or ex- wife’s earnings record. Or if your actual or ex-spouse is deceased, you can collect survivor benefits on her earnings record.
Mary Lou Jackson — Abington, Mass.: My husband just died at age 60. I am working full time. Can I collect his Social Security now?
Larry Kotlikoff: I’m extremely sorry for your loss. But you need to be age 60 or older to collect. And even if you are, here’s a warning: if you are below your full retirement age and earn beyond a certain amount, you will lose all, much, or some of your survivor benefits due to the earnings test. (Full retirement age these days is 66 for anyone born before 1955. This page on the Social Security website tells you what it is if you born in 1955 or later.
Even if you weren’t working, however, and were, say, age 60, it might be in your interest to wait until full retirement age to start collecting your survivor benefits. If you collect them early, they will be permanently reduced — by 30 percent if you start them at 60. When to start your survivor benefits depends critically on your earnings record and that of your deceased husband’s.
Sarah — Flint, Texas: If, at 66, I file for my divorced spousal benefits and wait until 70 to collect my Social Security, then my ex-spouse dies with a larger Social Security, would I be able to file for it if it is larger than mine and I have already collected four years of divorce benefits between my age of 66 and 70?
Larry Kotlikoff: Yes. Your divorcee survivor benefit can exceed your divorcee spousal benefit.
John Fisher — Guelph, Ontario: I am a Canadian resident and citizen. I worked in the U.S. for a little over five years. I earned 26 credits, short of the 40 required for a full Social Security benefit. Am I entitled to a partial benefit? Do the rules about delaying benefit still apply? I am 65 and reach official retirement age when I am 66.
Larry Kotlikoff: You should qualify for a totalization benefit from the U.S.. Since you have at least six U.S. quarters of coverage, credit can be given for your work under the Canadian Social Security program in order to entitle you to U.S. benefits. Delayed retirement credits can be applied to totalization benefits, so you can get 32 percent more by waiting until age 70.
This entry is cross-posted on the Rundown — NewsHour’s blog of news and insight.