The Social Security Act was signed into law more than 85 years ago. While the fundamentals and foundation of the program have remained intact, there have been numerous changes to the program over time.
More than 2,700 rules govern the Social Security program, which makes it nearly impossible to know every single thing about Social Security. Since you are a financial advisor, however, your clients likely expect you to have sufficient knowledge to answer their Social Security questions and guide their Social Security decisions.
The Social Security program and its rules are complex, but the more you learn, the better you are able to educate and serve your clients. A complex topic that is commonly overlooked is the taxation of Social Security benefits. Your knowledge and guidance on this topic will have a direct impact on your clients’ financial futures.
Here are three things you and your future retiree clients should know about Social Security and taxes.
1. Social Security income may be subject to federal, and possibly even state, taxation.
For almost 50 years after President Franklin D. Roosevelt signed the Social Security Act in 1935, Social Security income was not allowed to be federally taxed.
But in 1983, during Ronald Reagan’s presidency, a major bipartisan agreement made significant changes to the Social Security program. One of these changes was to allow a portion of Social Security benefits to be subject to federal taxation.
Even today, your clients may be unaware that their Social Security income may be taxed.
Federal taxation does not apply to all Social Security beneficiaries. A formula is used to determine if one’s Social Security income will be taxed. This determination is dependent on their combined income, also known as provisional income.
Combined income equals 100% of adjusted gross income (AGI) plus 50% of Social Security income plus 100% of tax-exempt interest.
If their combined income exceeds specific threshold amounts, a portion (up to 85%) of their Social Security income will be taxed. These threshold amounts vary depending on if they are a single or joint filer.
When a retiree’s Social Security income is taxed, it is taxed at the same rate as all their other income.
In addition to federal taxation, there are currently 13 states that also tax Social Security benefits. Some of the states use the same calculation as the federal government to determine if and how much Social Security income is taxed, and others have their own regulations.