Q: Would you please explain what happens when one reaches the age of 70½?
I participated in 401(k) investments when I was employed, but no one prepared me for what would happen when I reached 70½.
I was led to believe that I would be in a different income-tax bracket when I retired, so I would pay less in taxes. It was never mentioned that Social Security benefits might be affected.
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We are paying taxes on 85 percent of our Social Security benefits.
Knowing what I know now, I’m not so sure I would have taken the same route.
After the Required Minimum Distribution is added, we are in another tax bracket.
A: You’re not the only person who has been blindsided by the taxation of Social Security benefits.
The tax was the brainchild of David Stockman.
He was the director of the Office of Management and Budget during the Reagan administration.
He slipped this little time bomb into the Social Security reforms that were adopted in 1983.
It was a time bomb because the formula is one of the few parts of our entire tax code that is not indexed to inflation.
As a result, very few people were affected in 1984, but many people are being affected in 2013. It will affect future retirees — your children and grandchildren — still more.
According to the 2013 Social Security Trustees Report, for instance, the taxation of benefits brought only $2.8 billion back to Social Security in 1984.
But last year the tax yield was nearly 10 times as much, $26.7 billion. The greater the rate of inflation, the greater the number of retirees affected.
Making up to 85 percent of your Social Security benefits taxable income increases your tax liability in two ways.
First, it increases the amount of income subject to tax.
Second, it increases the average tax rate that you pay on your income.
The only good news here is that no more than 85 percent of your Social Security benefits can be added to your taxable income.
Once that has happened, the burden is done — except that the unexpected additional income may have moved you into a higher tax bracket, one that you didn’t expect when you retired.
But if you are paying taxes on 85 percent of your benefits now, you won’t be burdened with an additional Social Security benefits tax in the future as your Required Minimum Distribution increases.
Copyright 2013, Universal Press Syndicate