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Welcome to How to Retire on Time, a show that answers your retirement questions. Say goodbye to the oversimplified advice you've heard hundreds of times. This show is about getting into the nitty-gritty so you can make better decisions as you prepare for retirement. Text your questions to 913-363-1234 and we'll feature them on the show. Don't forget to grab a copy of the book, How to Retire on Time, or check out our resources by going to www.retireontime.com.
Welcome to How to Retire on Time, a show that answers your retirement questions. My name is Mike Decker. I'm a licensed financial adviser and fiduciary. And joining me here, Mr. David Franson.
Mike:David, thanks for being here.
David:Yep. Happy to be here.
Mike:As always, we're gonna answer your questions. Text them to (913) 363-1234. And remember, this is just a show, not financial advice, so make sure to do your research and follow-up with whatever we talk about. David, let's begin.
David:Hey, Mike. I heard that Social Security is now tax free. Is that true? That is not true. I know
Mike:that many politicians are saying that, including president Trump has said we got Social Security to be tax free. It's not an accurate statement. So just for context, as of the time of this recording, around 64% of people receiving Social Security were receiving it tax free, and that's under the Social Security tax brackets that if you make less amount of money or a certain amount of money, that 0% of your Social Security be subject to tax. Okay? And then there's 50% of your Social Security would be subject to tax, and then 85% of it.
Mike:So it's important to understand that 64% or so of people receiving benefits just were living off of very little. So basically 0% of their social security is being taxed. Okay. You with me so far?
David:Yeah. So federal we're talking federal income taxes, well over half, currently just don't even pay taxes on those benefits.
Mike:Yep. K. The changes that have been implemented by the one big beautiful bill are expected to increase that amount to about 88% of those who receive their benefit do not have to pay taxes. Now the question that's the most important question is, how does that happen? And what I found is many people, they know that they file their taxes.
Mike:They know roughly that there are things like the standard deduction, and there's tax deductions there that you might itemize. There's tax credits, and it credits a dollar for dollar off deductions, not dollar for dollar. There's all these things that go into a tax return. But if you had to ask someone, well, what's the order of the tax return, and how is it calculated? I found most people don't actually know that process, which is fine.
Mike:Yeah. I don't know the process for a surgery. I couldn't go to court until you do process of what a court proceeding is. I mean, I don't know these things. So it's normal for someone to say, I don't know the sequence of the tax return filing preparation because that's not my specialty, and TurboTax is a great way to file your taxes.
Mike:Right. But the calculations are happening in the background. They made it really easy for people so you don't have to think about it. Well, right now, you do need to think about it. Here's why.
Mike:I've gotten so many calls from people saying, how does my file strategy change because of the new one big beautiful bill changes for Social Security? I hear that it's now tax free, and should I it's the wrong question. And the reason is they didn't change Social Security taxation. What they did was they have adjusted the standard deduction so that if you are 55 years or older and your modified adjusted gross income is less than a certain threshold, so for married couples, if it's less than 150,000, then you get an additional 6 to 12,000, so 12,000 for, you know, a couple. Mhmm.
Mike:You get an additional amount of your adjusted gross income to be deducted from your return. So Okay. Whether you're taking Social Security or not, it's irrelevant. It's does your modified adjusted gross income, is that low enough that you qualify for an additional deduction on your taxes overall?
David:Okay.
Mike:So let me walk you through really quickly the order, the correct order in doing tax preparation. K? First off, you have to figure out how much of your Social Security is taxed. How does that happen? It's called the provisional income, and the calculation for the most part is as follows.
Mike:Take your total Social Security benefit if you're taking it, divide that in half. Now add in all of your taxable income. So pensions, if you've got an annuity that's from a pretax account like an IRA annuity, that could be taxed. You've got your w two ten ninety nine income. Any taxable income stream.
Mike:Right? You're gonna add all of that in there, and then any of your tax deferred or exempt income. So specifically, think of your municipal bond interest. K? All of that gets calculated dollar for dollar plus half your Social Security, and that helps you figure out, okay.
Mike:Am I paying 0% of my Social Security benefits taxes, 50% in taxes, or 85% subject to income tax? Are you with me so far? Yeah.
David:So if I made $5,000 a month in Social Security benefits, it's potentially, I'm paying 85% of that 5,000 a month is getting taxed potentially.
Mike:Maybe. Not necessarily. Depends.
David:Okay.
Mike:So for a couple, zero to 32,000 is the threshold. So 5,000 a month in Social Security benefits. Let's say as a household, that's what? 60,000 a year. 60,000 divided by two would be 30,000.
Mike:You would be in the 0% of Social Security being taxed if you had no other income.
David:Oh, right.
Mike:Right. Right. Or maybe it all came from your Roth as an example. But if you took $2,000 or more, your Social Security taxation is immediately bumped from zero to 50 or 85% subject to tax. This isn't a progressive situation like the income taxes.
Mike:This is all or none, you and gotta figure out where you stand. So things like dividends, whether you're using them or not, if they're being reinvested in your brokerage account, can disrupt this calculation. Leaning into municipal bonds can disrupt the provisional income tax calculation. These are important things to understand because, oh, well, that's tax free, kind of, but it could affect other parts of your plan. K?
Mike:So that's the first part. So you gotta figure out, okay, is your Social Security subject to 050, or 85% subject to taxes? That's the first part. Then you've gotta go over and figure out, okay, what is your adjusted gross income? So that calculation now is the taxable part of your Social Security.
David:Okay.
Mike:K? So whether it's like, if you have 60,000 in Social Security, but you've got a little income elsewhere, so maybe it's 50% of your Social Security is gonna be taxed as income, or 85% of it's taxed as income. All of your taxable income is a part of your adjusted gross income, but your municipal bond interest, for example, is not a part of this taxation because it's your adjusted gross income. So we're trying to figure out then what is your adjusted gross income provision because you need to do that then to figure out what your capital gains bracket is. So if you're taking income for your long term you see how this gets complicated?
David:Lots of moving parts I'm seeing here.
Mike:K. So I'll gloss over the next little bit here, but you figure out that is your long term capital gain subject to a 0%, 15%, or 20 in capital gains if it's long term. Okay? And so if that happens, then you figure out that calculation, and then you move on to the next part of the calculation, and I'm simplifying. So the CPAs are probably rolling over going, oh my gosh.
Mike:Look. This is a podcast. This is a radio show. We're keeping it simple. There's a lot of nuance when filing your taxes.
Mike:I'm keeping it simple. But you gotta figure out your modified adjusted gross income next. And the reason is, the question is, in this situation, is your standard deduction gonna apply and that's it, or are you gonna have the standard deduction plus this new one big beautiful bill deduction as well, which will sunset in 2031? And so if that happens, then you get your taxes, and then it's like based on your modified adjusted gross income. Here's your calculation.
Mike:Now you get the standard deduction, and maybe you qualify for this new additional deduction for seniors. So maybe you have an additional 12,000 that's getting deducted from your total taxable amount, and all of that then calculates to then the income tax brackets and so on. So the question is, oh, well, Social Security is now tax free. No. It's not.
Mike:They've changed the standard deduction to try and help more people not pay taxes or offset the taxes they would have paid in their Social Security, but it's not an apples to apples situation because you could utilize this to just do more IRA to Roth conversions if you're within the modified adjusted gross income threshold for your situation. You could use it to manipulate other parts of your plan. It's just it's not actually tied to Social Security. The truth is that they increase the standard deduction to offset some people's Social Security taxes to try and alleviate them, while other people who are making more money are receiving no relief, and it's just kind of the same as it always was. So for those enjoying $203,100,000 in retirement according to your modified adjusted gross income, this is irrelevant.
Mike:It doesn't make a change.
David:Because they'll still be paying the same old that they've always paid.
Mike:Right? They just they don't qualify for this deduction. It really was the wealthy are not receiving these benefits. Those who are enjoying less in retirement are enjoying these benefits, and they should be utilized. I fear that those who have 700,000 or less don't understand the magnitude of the next few years, the next five years, and how if it's done right, the standard deduction plus these additional deductions, how it can potentially significantly help their overall tax and income planning in retirement.
David:So it sounds like good news then for a large chunk of people.
Mike:Yeah. For people that have less than a million dollars in their IRA accounts, this is a huge opportunity, and it depends on, you know, how much do you have in your pension, what your Social Security there's lot of factors in here, but it's a huge opportunity to just move more money where it needs to go in preparation for things like required minimum distributions and legacy planning and so on, the list goes on and on and on.
David:And so how would the average people out there, how would they even know about all these nuances and all this?
Mike:It's so complicated. It it allows us to become nostalgic for the good old days of the pension. Oh, yeah. When you worked for thirty years, you got a pension, and you lived off it, and all was well. There's a reason why I think we as a people really enjoyed the pension.
Mike:Now I know there are some people that enjoy the four zero one k, and they like the additional flexibility, But when you get down to the core of an individual, I would say most Americans would have rather enjoyed a pension than the additional responsibility of having to figure out how do you take this four zero one k and navigate the tax nuance, the income nuance, the market nuance, even the health care nuances, now it affects all these different factors and the longevity risk, and I mean, it just there are 60 risks that you may not know exist. But this is how it is, and we move forward. Yeah. So I wanna point out something that's really important though in this conversation. As humans, we like simplicity, especially when it comes to retirement planning.
Mike:But if you'll notice, there's been a significant change, not just in the tax planning side of it, but a number of other parts of now how our financial system works. If you're living off a pension or if you bought an annuity and turned on that lifetime income stream, there's really nothing you can do to adjust your retirement to take advantage of these opportunities. You are in a reactive position. Now for all those who built a plan that offered them growth and flexibility with sufficient protection, because when I say sufficient protection, I mean that they have enough protected for the down markets. When the markets crash, they can sail through it.
Mike:For those that have that flexibility, they're the ones that are rewarded for these changes, because the tax code is written in pencil. It changes from time to time, and unless you can dynamically change your plan, your income plan, your tax plan, your health care plan, all of the above. You just might miss these huge opportunities, and that's one of the biggest takeaways I think from this question. That's all the time we've got for the show today. If you enjoyed the show, consider subscribing to it wherever you get your podcasts.
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