By Greg Strong
The MONY Group
About 20 percent of Americans who receive Social Security have to pay taxes on their benefits.
If you are among those 20 percent, you should learn how the tax advantages of annuities can help you.
When is
Social Security taxed?
In 1983, Congress passed a law that up to 50 percent of Social Security Income could be taxed when combined income exceeded specified threshold limits.
In 1993, the law was amended again to allow up to 85 percent of Social Security Income to be taxed under certain conditions.
According to the Social Security Administration website (www.ssa.gov), the general guidelines on taxation of Social Security benefits are:
If you file a federal tax return as an individual:
4 And your combined* income (threshold) is between $25,000 and $34,000, you may have to pay taxes on 50 percent of your Social Security benefits.
4 If your combined income (threshold) is above $34,000, up to 85 percent of your Social Security benefits are subject to income tax.
If you file a joint return:
4 You may have to pay taxes on 50 percent of your benefits if you and your spouse have a combined income (threshold) that is between $32,000 and $44,000.
4 If your combined income (threshold) is more that $44,000, up to 85 percent of your Social Security benefits are subject to income tax.
What is income?
Interest income is included in the definition of combined income with one notable exception – interest earned within tax deferred instruments, including tax-deferred annuities.
For retirees not planning to draw current interest income, deferred annuities are an effective financial vehicle for controlling the tax implications of social security earnings.
Tax-deferred annuities allow interest to grow without being included in the definition of combined income, until withdrawal.
Reduce the tax!
If the taxpayer is not spending his or her taxable interest, consideration should be given to moving the underlying funds to a tax-deferred vehicle.
This would help reduce current period taxes resulting from recapture of Social Security benefits.
To understand how this can be accomplished, let’s first look at how Social Security income is taxed through this hypothetical example.
Mary, age 67, is single. Her annual income is from the following sources:
Social Security $11,400
Pension $19,200
Interest income^ $14,400
Total $45,000
^Interest income is from CDs, Money Market accounts, Passbook Savings, Bonds and Stock Dividends. Mary is re-investing her interest income.
Will Mary have to pay tax on her Social Security income? Let’s see, by applying the government’s definition of combined income:
Half of Soc.Sec. $ 5,700
Pension $19,200
Interest Income $14,400
Total $39,300
Threshold (Single) $25,000
Exceeded threshold $14,300
How the $14,300 is calculated:
50% x $9,000 = $4,500
85% x $5,300 = $4,505
Total: $9,005
That means $9,005 of Mary’s Social Security income is subject to tax. If Mary is in the 2001 Federal tax bracket of 27.5%, her potential tax on Social Security is $2,476!
Reducing the tax bill
By transferring taxable interest income into a tax-deferred annuity, Mary can reduce her tax bill. (Remember, Mary is not using her interest income for living expenses.) That changes her reportable income to:
Social Security $11,400
Pension $19,200
Total $30,600
Now let’s use the same formula to determine her combined income:
Half of Soc. Sec.: $ 5,700
Pension $19,200
Total $24,900
Mary’s income is now below the $25,000 threshold for single filers, so the tax bill on her Social Security income has been reduced to $0! With annuities, you pay income taxes on the interest income only when you decide to withdraw your money. Please consult a financial advisor to determine if your own personal situation allows for tax savings.
(This information provides an example of the advantage of tax-deferred annuities. This article is not intended to give tax or legal advice. Tax rates given and treatment of social security as taxable income are from IRS codes for 2001. They are subject to changes in tax rates and rules. Please consult a tax professional to determine the applicability of your situation.)
* “Combined” income means your combined adjusted gross income as reported on your Form 1040, plus nontaxable interest, plus one-half of your Social Security Benefits.
Greg Strong offers Free Consultations in Lewiston, Augusta, Yarmouth, Naples, South Portland and Saco, give his office a call toll free at 1-877-533-6669
Help your beneficiary pay the tax bill
Remember, annuities are tax-deferred, not tax-free. If you die while owning an annuity, your beneficiary could end up paying more income taxes because of the annuity proceeds.
If this is an important issue for you, ask about annuities with a death benefit rider. Beneficiaries get money from one rider tax free! These riders can be complicated, so make sure you fully understand one before selecting it as part of an annuity
Summary
With sales in the hundreds of billions of dollars, annuities are one of the most popular ways to save money for and during retirement. Because there are so many annuity choices, you should first talk to a financial professional about your specific financial situation.
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