Don’t like the tax bill you got this year? Check your Social Security income

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Focus on Finance: April 22, 2012

By Steve Wright

Question: Does my Social Security vastly affect my taxes?

Answer: When you filed your income taxes this year, your tax bill may have unpleasantly surprised you. And if this is the case, you are by no means alone.

There can, of course, be many reasons why your taxes could be higher than you expect, such as having to report a capital gain or taking a lump-sum retirement plan distribution.

But one of the major culprits of this problem can, perhaps surprisingly, be the income you draw from Social Security. When Social Security began back in the 1930s, it originally was slated as tax-free income and remained so until 1984.

However, over the years, Congress has enacted legislation that has eroded its tax-free status. The general parameters for the current taxation of Social Security are broken down as follows:

Once your income respective to your filing status reaches these levels, then 50 to 85 percent, respectively, of your Social Security income can become taxable. This quickly can have a substantial impact on your tax return, as many Americans receive up to $20,000 of social security benefits per year.

Furthermore, very few recipients have any tax withheld from this income, as most believe they will not be taxed on it. But even a modest pension income can make a large amount of your Social Security benefits taxable.

For example, if you are single and you draw $15,000 a year from a company pension, and you also receive $16,500 in Social Security benefits, then up to 85 percent of your benefits are subject to taxation.

Mathematically, that comes out to around $14,000, resulting in a possible tax bill of $2,100 – assuming an effective tax bracket of 15 percent federal.

And, of course, if you have additional investment income of any kind from bonds, CDs, or mutual funds, then that will increase your taxes as well.

The good news is, for many Americans, there are ways to either eliminate or greatly reduce their tax bills. One of the key methods to achieving this is by moving taxable fixed-income assets into tax-deferred fixed annuities.

This effectively allows the taxpayer to only pay tax on the actual taxable portion of each distribution, and not on the interest that still is compounding within the annuity.

With taxable CDs or other fixed income investments, all interest is taxable, whether it is paid out or not. This income can, therefore, also increase the taxation on your Social Security benefits.

Steve Wright is managing member of The Wright Legacy Group, LLC.

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