Income Taxation of your Social Security Benefits

by Glenn J. Downing, MBA, CFP®

Many new Social Security recipients are surprised to learn that their benefits are taxable.  But they are, and have been since the Clinton administration added a formula to the tax code to determine how much, if any, of your Social Security benefit is subject to tax.  Before that time social security benefits were not taxed at all.

This formula is called the provisional income formula.  It boils down to this:  add all of your income together – wages, business earnings, tax-free bond income (yes – non-taxable income is included in this formula!), IRA distributions – everything – plus ½ of your social security benefit.  If the result falls into these ranges, and you are married filing jointly, then that portion of your social security income gets taxed along with everything else:

  • <$32,000, none
  • $32,000 to $44,000, to 50%
  • >$44000, to 85%

For single filers, the numbers are these:

  • <$25,000, none
  • $25,000 to $34,000, to 50%
  • > $34,000, to 85%

For a married taxpayer filing jointly, does this mean that 85% of his social security will be taxed away?  Fortunately, no!  It means that up to 85% of the social security payments will be added in with all of the other taxable income.  Here’s an example:

A married couple has this income:

$18000 pension income

$6000 IRA distributions

$12000 municipal bond interest (non-taxable)

$24000 social security income ($2000/month)

Now apply the provisional income formula.  The result is ($18K + $6K + $12K +$12K) = $48,000.  $48,000 is more than $44,000 (from the table above); consequently 85% of the social security benefit will be added to the other taxable income.  Note that although the income above totals to $60,000, their taxable income is as follows:

$18000 pension income

$6000 IRA distributions

$20400 social security income (85% of their benefit)

For a taxable income of $44400.  This is $15,600 less than their gross income, since the municipal bond income is not taxed – but is used in the provisional income formula – and only 85% of the social security income is taxed.  The tax on $44,400, assuming the standard deduction, is $2615.

Is there anything that can be done here to reduce taxes?  In this scenario, yes there is, because the provisional income is very close to the $44,000 limit.  The only way to save taxes is to keep provisional income below $44,000.   How could the taxpayer do that?  By re-positioning the municipal bonds into a deferred annuity.  At 3%, it would take $333,333 of muni bonds to produce $10,000/year of income.  If these bonds were repositioned into two annuities – one deferred and one immediate – the taxable income could be reduced down to about $1850.  Now look at the provisional income:

$18000 pension income

$6000 IRA distributions

$1850 annuity distribution (taxable portion)

$12000 social security income (1/2 the benefit of $2000/month)

By the formula, the provisional income is ($18000 + $6000 + $1850 + 12000)

Or $37850.  Now the taxpayer has only 50% of social security taxed.

The taxable income is now:

$18000 pension income

$6000 IRA distributions

$1850 annuity distribution (taxable portion)

$12000 social security income (taxable portion)

=$37850.  The tax on this amount, assuming the standard deduction, is $1715.  So by repositioning the savings out of municipal bonds into an annuity, there is additional annual cash flow of $865.00.

Clearly if the provisional income is well above $44,000, there isn’t much to be done to try to save taxes.  But if someone’s number is in that vicinity, it is well worth it have a look.

I hope we’ve provided good information for you here.  If you have any questions, by all means get in touch:  Visit our website at, where you’ll see all of our blog entries and be able to book an appointment to come see us.

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