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Originally published Saturday, May 3, 2014 at 8:00 PM

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Taxation of benefits can make you crazy

A reader concerned about taxation of retirement benefits gets some assurance.


Syndicated columnist

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Investing

Q: I have concerns about Social Security and my income taxes. Many people support these two ideas:

• Delay taking Social Security until you are 70 if at all possible.

• Let your 401(k) grow tax-free as long as possible if you have other funds you can tap.

So here is my question: By the time I turn 70, my 401(k) will likely be worth well over $2 million.

When I turn 70½ and begin the mandatory withdrawals, my income will be large, and that will put me in a higher marginal tax rate. It will also make my Social Security taxable. The double whammy will basically wipe out the Social Security benefit for me.

I am confused about what I should do in the 15 years leading up to my 70th birthday.

I am leaning toward taking benefits early, when I turn 62, rather than lose them in the future. This would help me let my 401(k) grow tax-free as much as possible before taking it out. It will likely be way more valuable to me than Social Security checks after I reach 70.

A: You’re in a quandary, but it’s a quandary in a great ZIP code. So the first thing I suggest is to remember that this is a nice problem to have.

The majority of retirees won’t face this problem because their only income will be from Social Security.

Still, it’s deeply vexing that the same two political parties that voted for the legislation to create 401(k) plans with the Revenue Act of 1978 then voted to, in effect, tax the income coming from those plans in 1984 when they approved the first tax on Social Security benefits.

Basically, our tax policy is a crazy-maker: It encourages one thing, and then punishes us for doing it.

What most people don’t understand is that while the taxation of benefits is a tax on benefits, we don’t experience it that way because it can be triggered only by having additional income from other sources — such as income from a tax-deferred 401(k) account.

It’s also an entirely middle-class tax because it will be over and done well before your total income exceeds $100,000.

For you, that’s the good news. While many readers need to figure out what money to use today to possibly limit the taxation of benefits tomorrow, you have enough assets that you can be certain your benefits will always be taxed, no matter what you do.

What that means is that you need to add 85 percent of your Social Security benefits to your taxable income, pay the tax, and get on with it.

Did both political parties abuse you? You bet. They sucked you into saving and investing — then they put a tax on your benefits. But you’re a fortunate guy. You saved and did well.

Questions: scott@scottburns.com

Copyright 2014, Universal Press Syndicate



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