Schedule your complimentary appointment with us here.
Social security numbers were introduced in 1936. The main intent was to create a social insurance program to pay retired workers, age 65 or older, an income after retirement. How is this social insurance program funded? By the taxpayers and corporations. The original contribution rate was 1% of pay, which was matched by employers at 1%. By 1950, the rate grew to 1.5%, and ever since 1990, the rate has held steady at 6.2%. That means the employee pays 6.2% of their income into social security and the employer pays 6.2% into it. That’s a lot of taxes. Then, 48 years later in 1984, Congress and President Reagan (which I was surprised to learn) approved the taxation of receiving social security benefits. So not only are workers incomes taxed now to go into the SS program, but also they are taxed later when the benefits come out of the SS program to the recipients. Up to 85% of it could be taxed by the federal government and 13 states apply state income tax on social security, too.
Federal Taxes on Social Security
Federal income taxes apply to your SS retirement benefits if your total income is above $25,000 for individual filers and above $32,000 for married, filing jointly (for 2020). Eighty five percent of benefits could be taxed for individual filers making more than $34,000, and for those married, filing jointly with more than $44,000 combined income. Therefore, many people, especially those with investable assets, easily hit those thresholds whereby their social security income is taxed.
State Taxes on Social Security
Since we are based in St Louis MO, we are going to use Missouri as an example. The same would generally apply no matter where you are from within Missouri, be it Kansas City, around St Louis, or a small town in Missouri. For those in Missouri, social security can be taxable. Missouri fully exempts social security benefits for recipients who earn less than $85,000 per year if filing single and $100,000 per year if filing jointly*. This is Adjusted Gross Income, meaning it is before your standard or itemized deduction and includes mostly all sources of income, except for possibly other public pension income like a teacher’s retirement system, which might have a deduction attributed to it.
Don't get taxed on Missouri Social Security
As noted above, for many people in Missouri, social security is taxable. So how can we work with these thresholds to reduce state taxes, no matter whether you live in St Louis, Kansas City, or elsewhere in Missouri? For many, we can adjust where we take income from, meaning do we take it from a pre-tax account, after-tax account, or a taxable account (where capital gains tax applies). Year 2020 proved to be an opportune time to reduce withdrawals from a pre-tax account since RMDs were suspended. Therefore, clients could reduce income from their traditional IRA, thereby reducing their AGI and Missouri state income tax on SS.
Another way for those in St Louis and elsewhere to eek out an efficiency of reduced state tax on SS is to tax-loss harvest. They could also reduce taxable income through asset location strategies, meaning place interest bearing investments in tax-deferred and tax-free accounts so it doesn’t hit AGI.
If someone in St Louis or elsewhere in Missouri who is married and filing jointly reduces their AGI from $105,000 to $98,000, they could reduce their state taxes on SS to $0 from about $5,489 (formula: [(105,000 – 8,424)*5.4% + $274])*,**.
Misconceptions on Social Security
The social security administration uses phrases and terminology that can be misinterpreted as advice or targets by the general public, including a few clients of mine. For instance, take “Full retirement age”. This does not mean that the government advises that you retire at that age or that you should target your retirement for that age. Instead, it simply means that this is the age at which you are entitled to your full benefits from SS. If you retire before that age, your benefits will be reduced. This is a common misconception; too many people confuse it and use it for a target. Instead, they should be using other factors to target a retirement age, such as the value and type of other investment accounts, such as IRAs, Roths, and regular accounts, and how much they need to live on.
How to rethink Social Security
For most people, ss retirement benefits will not be enough to sustain their lifestyle throughout retirement. Instead, it will supplement what they need. So, assuming they have built up retirement accounts and regular, taxable investment accounts, then they can optimize their plan by rethinking ss and using it almost like a hybrid between a guaranteed return and downside protection insurance.
Here’s how: When you delay SS past full retirement age up to age 70, the social security administration guarantees an increased payout of 8% per year. So they are guaranteeing an 8% return as long as you delay and not beyond age 70. I tell clients that we cannot guarantee an 8% return on their investment accounts – financial advisors are not allowed to make guarantees like that. So, if the government is going to make a guarantee like that, let’s take them up on it.
The next common question is: how do we replace that ss income when we are delaying? This is where custom planning comes into play. Assuming they have the assets elsewhere, we can draw on those assets for income until Age 70. Then at age 70, after the government has given us that 8% return, we reduce the income from the other assets and start taking income from SS.
Social Security as insurance or a buffer
Assuming all the above, we can also use SS like insurance or as a safety net. Our practice talks about downside protection planning often. And a lot of time we incorporate delaying SS into that. The worst time to sell is when markets are down. So, what if you have delayed SS, are drawing on your investment accounts for income, and then a market downturn occurs? Well, we’ll use the SS as a buffer so you don’t have to sell when markets are down. What we’ll do is “turn off” the income from your investment accounts and “turn on” income from your SS. So, we’ll delay as long as we can until age 70 or until there is a downturn, so that we do not sell out of your investments during a down market. This is just one component of downturn protection planning.
It’s apparent there are many ways for those in St Louis MO and across the country to rethink and take advantage of social security for their needs when they need them instead of just taking it as early as you can. If you have a need for retirement planning, reach out to us here at One Bridge. We offer traditional financial advising both in person and virtually, using our virtual financial advisor tools, like Zoom and Docusign.
No matter the area, a quick internet search such as, social security administration St Louis MO, will show you where you can locate your local SSA office. The social security administration St Louis MO offices are located throughout the area.
Also looking to save for retirement? Learn here how to save for retirement.
Schedule your complimentary appointment with us here.