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The Taxation Of Social Security Benefits As A Marginal Tax Rate Increase? Part VI

6/28/2014

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In this blog, we will wrap up our previous discussions on the taxation of social security benefits as a margin tax rate increase.

Strategy 3. Defer Taxes
Tax deferral strategies can also be appealing to manage Social-Security-triggered higher marginal tax rates.  This might not only include just continuing to maintain and stretch tax-deferred IRAs (to the extent they're not converted), but also the use of non-qualified fixed or variable annuities to defer income; while tax-deferral doesn't eliminate exposure to the effect entirely, it's nonetheless true that tax deferral itself is worth a whole lot more when someone's marginal tax rate is so high!  Similarly, effective asset allocation strategies to shelter the most high-income tax-inefficient assets also become more important where one's marginal tax rates are so high.  

Strategy 4. Not to Invest in Tax-free Income 
On the other hand, it's notable that strategies like investing in tax-free income to avoid high Social-Security-taxation marginal rates does not work, since municipal bond income is itself included in provisional income!  


The end result is that while the bonds themselves still wouldn't be taxable, they would still face a 7.5% - 12.75% marginal tax rate (for those in the 15% tax bracket) as 50% or 85% of Social Security benefits become subject to taxation.  Similarly, the impact can also boost the marginal tax rate for capital gains, which may enjoy a 0% tax rate for those in the bottom tax brackets, but nonetheless increase AGI and provisional income and therefore indirectly trigger the taxation of Social Security benefits.

The Bottom Line
Unfortunately, the reality is that no two people will be exactly the same for their exposure to higher marginal tax rates from the taxability of Social Security benefits, because the exact scope varies depending on both the nature of their taxable income and the total amount of their Social Security benefits that may be subject to taxation in the first place. 


For some people with smaller benefit payments, the impact is fairly limited; for others with a very large pool of payments, the effect can continue over a much wider range of income and spanning across not just the 15% tax bracket (with 27.75% marginal rates) but the 25% bracket (with 46.25% marginal rates). 

Ultimately, everyone will cap his or herexposure when the maximum 85% of Social Security benefits are being taxed, but the exact level of this cap itself will vary depending on the amount of Social Security being received. Which means in the end, the analysis must be done on a personal basis... but with potential 46.25% marginal tax rates, it's worth the effort!
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