In Part III our blog posts, we discussed the impact on couples, now we discuss the impact on individuals.
Impact on Individuals
For individuals, the effect can be even more severe, because the taxation of Social Security benefits potentially overlaps not just the 15% tax bracket, but the 25% tax bracket (which starts at "only" $36,250 for individuals). As a result, individuals could face a potential tax rate boost from 25% to 46.25%!
The Example of Harry
Harry is an individual with $36,000 of income but a hefty $22,000/year of Social Security benefits. His Social Security provisional income is $36,000 + $11,000 = $47,000, which is $13,000 over the upper threshold for individuals. As a result, $15,550 of his Social Security benefits are subject to taxation (which is 50% of the amount from $25,000 to $34,000, plus 85% of the excess of provisional income above the $34,000 threshold), which puts his AGI at $51,550. Even after a standard deduction and one personal exemption, Harry's taxable income would be $51,550 - $6,100 - $3,900 = $41,550, which places him in the 25% tax bracket.
If Harry now takes an additional $1,000 from his IRA, his provisional income increases to $48,000, his taxable Social Security benefits increase to $16,400, and his AGI rises to $53,400. The net result: Harry's AGI increased by $1,850 for "just" a $1,000 IRA withdrawal, and with a 25% tax bracket his liability will be $1,850 x 25% = $462.50, which equates to a whopping $462.50 / $1,000 = 46.25% marginal tax rate!
The Bottom Line
In reality, it takes a unique combination of income and Social Security benefits to face this 46.25% marginal tax rate, although it is possible; due to how the tax brackets line up with the Social Security taxability thresholds, it's more common for individuals than married couples (the latter generally don't see this 46.25% marginal tax rate unless they are slowly phasing in a very large pool of combined Social Security benefits).
Because the tax brackets are indexed for inflation while Social Security benefits are not, the overlap of 85% Social Security benefits inclusion and the 25% tax bracket is actually declining over time (as the 10% and 15% brackets widen slightly each year). Nonetheless, the fact remains that the phase-in of Social Security benefits can result in surprisingly high marginal tax rates for someone with relatively "modest" income levels - as even a 15% tax bracket can be boosted up to 27.75%!
Impact on Individuals
For individuals, the effect can be even more severe, because the taxation of Social Security benefits potentially overlaps not just the 15% tax bracket, but the 25% tax bracket (which starts at "only" $36,250 for individuals). As a result, individuals could face a potential tax rate boost from 25% to 46.25%!
The Example of Harry
Harry is an individual with $36,000 of income but a hefty $22,000/year of Social Security benefits. His Social Security provisional income is $36,000 + $11,000 = $47,000, which is $13,000 over the upper threshold for individuals. As a result, $15,550 of his Social Security benefits are subject to taxation (which is 50% of the amount from $25,000 to $34,000, plus 85% of the excess of provisional income above the $34,000 threshold), which puts his AGI at $51,550. Even after a standard deduction and one personal exemption, Harry's taxable income would be $51,550 - $6,100 - $3,900 = $41,550, which places him in the 25% tax bracket.
If Harry now takes an additional $1,000 from his IRA, his provisional income increases to $48,000, his taxable Social Security benefits increase to $16,400, and his AGI rises to $53,400. The net result: Harry's AGI increased by $1,850 for "just" a $1,000 IRA withdrawal, and with a 25% tax bracket his liability will be $1,850 x 25% = $462.50, which equates to a whopping $462.50 / $1,000 = 46.25% marginal tax rate!
The Bottom Line
In reality, it takes a unique combination of income and Social Security benefits to face this 46.25% marginal tax rate, although it is possible; due to how the tax brackets line up with the Social Security taxability thresholds, it's more common for individuals than married couples (the latter generally don't see this 46.25% marginal tax rate unless they are slowly phasing in a very large pool of combined Social Security benefits).
Because the tax brackets are indexed for inflation while Social Security benefits are not, the overlap of 85% Social Security benefits inclusion and the 25% tax bracket is actually declining over time (as the 10% and 15% brackets widen slightly each year). Nonetheless, the fact remains that the phase-in of Social Security benefits can result in surprisingly high marginal tax rates for someone with relatively "modest" income levels - as even a 15% tax bracket can be boosted up to 27.75%!
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