By Hans E. Scheil, CFP®, CLU®, ChFC®, CASL®
When clients come to us for a financial plan their main goal is to arrange for a secure retirement. Part of that security and a major element for many retirement portfolios is Social Security. Unfortunately, as much as people will come to depend on Social Security, many do not understand some fundamental basics. Some of the most common questions are listed below.
Do I Have to Pay Income Taxes on My Social Security Check?
It depends. To start, no one pays federal income tax on more than 85% of their Social Security benefit, and some people will not pay any federal income tax. It is determined by how you file your taxes, as well as your combined income. Combined income = adjusted gross income + nontaxable interest + half your Social Security benefits.
If you file as an individual and your combined income is under $25,000, you will not pay any federal income tax on your benefit. If your combined income is between $25,000 and $34,000, you will pay tax on up to 50% of your benefit. If your combined income as an individual is more than $34,000, up to 85% of your benefit will be taxed.
These numbers change if you file a joint return. If you and your spouse have a combined income that is under $32,000, you will not pay taxes on your benefit. From $32,000-$44,000, you will pay tax on up to 50% of your benefit. Over $44,000 is when you will pay up to 85% of your benefit. (For related reading, see: How Are Social Security Benefits Estimated and Taxed?)
If you are married and file a separate tax return, you most likely will pay taxes on your benefit. While the percentage taxable works as a sliding scale (a single person with a combined income of $35,000 will pay a smaller percentage in income tax than a person with $80,000) this scale gets steep fast.
How Do Spousal Benefits Work?
Spousal benefits are another area of misinformation. First, if you have a full earnings record and a benefit equal or close to your current or former spouse, this really does not apply to you, as you will most likely file on your own benefit. If this is not your situation, you can file on an ex-spouse, a deceased spouse, or a current spouse. When you file on someone, you receive 50% of their benefit.
You can file on an ex-spouse if you were married for over 10 years and did not remarry prior to the age of 60.
If you are widow or widower, you can start collecting on your deceased spouse’s benefit as early as 60, though the benefit might be reduced if collected before your full retirement age. There are many aspects that affect the amount of the benefit a widow or widower will receive, including when their spouse died and if benefits started yet.
When a spouse dies, the surviving spouse gets to continue receiving the larger benefit, but the smaller benefit goes away. For example, if there was a husband and wife, with the husband receiving $2,000 a month and the wife receiving $1,000, and the husband died, the wife would start receiving the $2,000 but the other $1,000 check would disappear. This is another aspect of spousal benefits that needs to be considered when deciding when to start collecting. (For related reading, see: How to Navigate Spousal Benefits Under New Social Security Rules.)
What Is Full Retirement Age (FRA)?
Many of the clients we speak with think FRA is age 65. This changed a while ago. While it is 65 for people who were born before 1938, for people retiring now, FRA is 66 and goes up gradually to age 67 for those born after 1960.
What Are the Ramifications of Filing Before My FRA?
Most are aware that monthly benefits are reduced when filing before full retirement age. Taking benefits at age 62 will significantly decrease the amount you receive. Benefits are further reduced if you file and go back to work, even part-time. If you are under FRA and go back to work, $1 for every $2 made in excess of the earning limit ($16,920 in 2017) will be deducted. This differs if you are in your FRA year. Once you reach FRA, you are allowed to make as much as you want.
Is There Ever a Situation When I Should File for Social Security Before FRA?
There are some situations where the answer to this question is "yes." If you need or want the income now, you should take it. Also, if you are in poor health and do not anticipate living past 75, taking the Social Security benefit early could maximize the money received over your lifetime. This will forever diminish your surviving spouse’s benefit though, and should be done with caution. There are also people who do not trust the government and think Social Security might not be around in their later years, so if filing early provides peace of mind, it could be worth it. (For related reading, see: Should I Collect Early Social Security?)
Lastly, clients who are over 62, retired and still have children who are in high school or younger might want to file early. For these people it is advantageous to take the benefit because their children can also get monthly payments if they qualify. There is a limit on how much each family can receive though, so make sure to research options. There are other situations where filing before reaching FRA might be the right option; these just represent some of the most common ones we see.
As you can see, there are many facets to determining your Social Security benefits. If you are unsure as to how to maximize your benefits, do your research and/or talk to a professional. Getting the right advice could make the difference of tens of thousands of dollars over your lifetime.
This article was originally published on Investopedia.