Author Topic: Social security taxed  (Read 5115 times)

SpendyMcSpend

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Social security taxed
« on: May 06, 2015, 06:56:53 AM »
Is social security taxes only if you have wage income or also interest or other passive income?  Also, when you withdraw from your 401k, you are taxed at your marginal rates not at capital gains and dividend rates... So aren't these both penalties of saving in a 401k and withdrawing as a retiree?

Snow White

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Re: Social security taxed
« Reply #1 on: May 06, 2015, 07:03:20 AM »
It is complex but social security is taxed more than I ever imagined depending on your income level and sources of income.  I will defer to one of my gurus (Scott Burns) as he explains it much better than I ever could!

Start here but he has several articles on his website that might help.  http://assetbuilder.com/scott_burns/the_other_enemy_of_401(k)_plans_(and_your_retirement)

dandarc

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Re: Social security taxed
« Reply #2 on: May 06, 2015, 07:06:45 AM »
I believe the worst case on social security (assuming we're talking normal retirement age or later here), is that 85% are subject to income tax.

So yeah, SS would push your income up.  All the more reason to retire early and get that 401K money converted to Roth at advantageous rates.

Trifele

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Re: Social security taxed
« Reply #3 on: May 06, 2015, 07:36:23 AM »
Snow White -- your link to the article looks broken (?)  Thanks

PathtoFIRE

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Re: Social security taxed
« Reply #4 on: May 06, 2015, 08:13:16 AM »
Above the posters have tried to answer the question about when/how much Social Security distributions are taxed, in other words, when you receive money from Social Security. I may have misread the OP's questions, but I got the sense that the question was about on what forms of income do you pay OASDI/SS taxes. To my knowledge, it is only paid on earned income, which results in you getting either a W2 (you pay half, employer pays half) or 1099 (you pay all, employer pays none) form from your employer. So "passive" income, such as interest, rents, dividends, etc., are for the most part not taxed.

Snow White

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Re: Social security taxed
« Reply #5 on: May 06, 2015, 08:37:42 AM »
Uh oh...not sure why my link didn't work.  It took me to the website but not the article in question.  Let me try again. 

http://assetbuilder.com/scott_burns/the_other_enemy_of_401(k)_plans_(and_your_retirement)

Darn...this looks like the previous link and it opens the correct article from my email so not sure it why it isn't working here.  I have to go to blogs and select Scott Burns to get to it.  I am on my way to yoga class (a benefit of early retirement!), but I will see if I can correct this when I get home. Sorry.

dandarc

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Re: Social security taxed
« Reply #6 on: May 06, 2015, 09:06:22 AM »
Above the posters have tried to answer the question about when/how much Social Security distributions are taxed, in other words, when you receive money from Social Security. I may have misread the OP's questions, but I got the sense that the question was about on what forms of income do you pay OASDI/SS taxes. To my knowledge, it is only paid on earned income, which results in you getting either a W2 (you pay half, employer pays half) or 1099 (you pay all, employer pays none) form from your employer. So "passive" income, such as interest, rents, dividends, etc., are for the most part not taxed.
Good point -  I think I misread the question.

FICA doesn't really come into play with 401Ks.  You pay them on the earned income when earned, and don't pay them on withdrawals from the 401K.  You have to have earned income to even be making 401K contributions as well, so I'd say if you need earned income (you are not yet retired), you're pretty much going to pay social security taxes, regardless of what you do with retirement accounts.

Cheddar Stacker

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Re: Social security taxed
« Reply #7 on: May 06, 2015, 09:07:50 AM »
Above the posters have tried to answer the question about when/how much Social Security distributions are taxed, in other words, when you receive money from Social Security. I may have misread the OP's questions, but I got the sense that the question was about on what forms of income do you pay OASDI/SS taxes. To my knowledge, it is only paid on earned income, which results in you getting either a W2 (you pay half, employer pays half) or 1099 (you pay all, employer pays none) form from your employer. So "passive" income, such as interest, rents, dividends, etc., are for the most part not taxed.

+1. Meadow, if this was your question regarding social security, PathtoFIRE answered it properly. In all fairness though, it was hard to understand exactly what you were asking.

SS/MED taxes are only collected on earned income, not investment income.

When you receive social security benefits they might be taxable, as Dandarc mentioned up to 85% of the benefit could be taxed at your ordinary rates. So $20K in SS income * .85 = $17K * 15% = $2,550 taxes. The 15% rate is just an estimate, it depends on other income.

On the second question, yes, withdrawals from 401k's are taxed at ordinary (marginal) rates. This is not so much a penalty for saving, it's more a benefit of deferring. If you make $100K and are in the 25% tax bracket, saving in a 401k can save you $4,500 in tax (18K*.25). When you retire and have $0 income, your $18K draw from your 401k will create taxable income, and if you're in the 15% bracket you will pay $2,700. So you're paying less tax than you would have it you simply spent that money, or saved it in a taxable brokerage account.

There are a lot of subtle things wrong with that last paragraph, like graduated tax tables, exemptions, deductions, etc., but I'm just trying to get the general point across. Tax deferral saves you a lot of money in taxes.

dandarc

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Re: Social security taxed
« Reply #8 on: May 06, 2015, 09:11:36 AM »
Uh oh...not sure why my link didn't work.  It took me to the website but not the article in question.  Let me try again. 

http://assetbuilder.com/scott_burns/the_other_enemy_of_401(k)_plans_(and_your_retirement)

Darn...this looks like the previous link and it opens the correct article from my email so not sure it why it isn't working here.  I have to go to blogs and select Scott Burns to get to it.  I am on my way to yoga class (a benefit of early retirement!), but I will see if I can correct this when I get home. Sorry.
The end parenthesis isn't included in the link - probably something weird with converting the text to a hyperlink.  Appears to be fixed when link is enclosed in url tags:

http://assetbuilder.com/scott_burns/the_other_enemy_of_401(k)_plans_(and_your_retirement)

Quick way to do this is to highlight the link in the editor and click the "Insert a link" button (it is the globe / document image just below the Italics button on the web-version of the forum).

SpendyMcSpend

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Re: Social security taxed
« Reply #9 on: May 06, 2015, 09:42:52 AM »
Actually my question was about whether you pay tax on SS (when retired) if your 401k distributions are your only income

SpendyMcSpend

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Re: Social security tax
« Reply #10 on: May 06, 2015, 09:46:40 AM »
Ok let's say you contribute a total of 100k to your 401k.  Your earnings are 500k.  So your tax paid at the end of all this is your tax rate times whatever you withdraw.  Let's say you take it all out at 70 and you get taxed on the whole amount.  Your tax rate wil be much higher on the earnings than it would have been over the years had your earnings been taxed at the capital gains rate.  Unless I'm misunderstanding when the capital gains rate is applied.  So if you out that same 100k in an after tax account to let it grow, the earnings will be taxed at 15%?

Cheddar Stacker

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Re: Social security taxed
« Reply #11 on: May 06, 2015, 10:10:39 AM »
Actually my question was about whether you pay tax on SS (when retired) if your 401k distributions are your only income

It depends, but likely yes. If you have $20K (ish) in other gross income, your social security income phases into becoming taxable up to 85%.

Ok let's say you contribute a total of 100k to your 401k.  Your earnings are 500k.  So your tax paid at the end of all this is your tax rate times whatever you withdraw.  Let's say you take it all out at 70 and you get taxed on the whole amount.  Your tax rate wil be much higher on the earnings than it would have been over the years had your earnings been taxed at the capital gains rate.  Unless I'm misunderstanding when the capital gains rate is applied.  So if you out that same 100k in an after tax account to let it grow, the earnings will be taxed at 15%?

By earnings of $500K you mean investment gains, yes?

If you took it all out at 70, you would not be doing it in a tax efficient manner, but yes you would pay a big chunk of tax right away, including on all the gains, and it would be taxed at ordinary rates. If you take out $600K in one year, you're talking about paying $200K in taxes, roughly.

If you put $100K into a taxable brokerage account, that $500K in earnings would be taxed at 15% over a number of years unless you were in the 10-15% bracket, then it would be taxed at $0.

What you are leaving out of the equation are two things:

1) You get a tax deduction for putting that $100K into the 401K, which would equate to $15-35K depending on tax bracket.
2) With proper tax planning you can move a lot of the $600K out of the 401K slowly and pay a rate at or below the 15% rate anyway.

Retire at 50, take out $50K/year, after deductions/exemptions your taxable income is maybe $30K, apply the tax tables and your result is about $3,500 (or 7% of the withdrawal).

Snow White

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Re: Social security taxed
« Reply #12 on: May 06, 2015, 04:51:16 PM »
Thank you Dandarc for explaining why my link didn't work!  😚

thd7t

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Re: Social security taxed
« Reply #13 on: May 07, 2015, 07:08:56 AM »
Actually my question was about whether you pay tax on SS (when retired) if your 401k distributions are your only income

It depends, but likely yes. If you have $20K (ish) in other gross income, your social security income phases into becoming taxable up to 85%.

Ok let's say you contribute a total of 100k to your 401k.  Your earnings are 500k.  So your tax paid at the end of all this is your tax rate times whatever you withdraw.  Let's say you take it all out at 70 and you get taxed on the whole amount.  Your tax rate wil be much higher on the earnings than it would have been over the years had your earnings been taxed at the capital gains rate.  Unless I'm misunderstanding when the capital gains rate is applied.  So if you out that same 100k in an after tax account to let it grow, the earnings will be taxed at 15%?

By earnings of $500K you mean investment gains, yes?

If you took it all out at 70, you would not be doing it in a tax efficient manner, but yes you would pay a big chunk of tax right away, including on all the gains, and it would be taxed at ordinary rates. If you take out $600K in one year, you're talking about paying $200K in taxes, roughly.

If you put $100K into a taxable brokerage account, that $500K in earnings would be taxed at 15% over a number of years unless you were in the 10-15% bracket, then it would be taxed at $0.

What you are leaving out of the equation are two things:

1) You get a tax deduction for putting that $100K into the 401K, which would equate to $15-35K depending on tax bracket.
2) With proper tax planning you can move a lot of the $600K out of the 401K slowly and pay a rate at or below the 15% rate anyway.

Retire at 50, take out $50K/year, after deductions/exemptions your taxable income is maybe $30K, apply the tax tables and your result is about $3,500 (or 7% of the withdrawal).
This is correct, but in addition, you pay taxes at your marginal rate on your initial investment (which is only $100k, but is still at your top tax rate).  This is all really an argument about optimizing withdrawls.
EDIT: in addition, in the 25% bracket, $100k of taxable account amounts to $125k in a 401k, so when you withdraw (assuming the same exact investments), the 401k is at $725k and the taxable account is at $600k
« Last Edit: May 07, 2015, 07:13:26 AM by thd7t »

Gin1984

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Re: Social security taxed
« Reply #14 on: May 07, 2015, 07:21:16 AM »
My mom is going to be paying tax on SS and it is going to be in the (mostly) 25% bracket because she has a pension.  But honestly, as much as I am for optimizing (and she is pulling some out now from her 401k because she is at 15%), if you are able to pull out so much that you pay a high rate, is that not a good thing?  I expect my SS to be taxed because I expect to have a decent sum in my 401k to pull out.

Cheddar Stacker

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Re: Social security taxed
« Reply #15 on: May 07, 2015, 08:51:48 AM »
This is correct, but in addition, you pay taxes at your marginal rate on your initial investment (which is only $100k, but is still at your top tax rate).  This is all really an argument about optimizing withdrawls.
EDIT: in addition, in the 25% bracket, $100k of taxable account amounts to $125k in a 401k, so when you withdraw (assuming the same exact investments), the 401k is at $725k and the taxable account is at $600k

This post confused me a bit because of the way it was worded, but I mostly agree with it after reading it a few times. Since you don't pay taxes on the initial principal when you put it in a 401k, the investment is larger than it would be in a taxable brokerage account. In the 25% bracket, you have to pay $25K in taxes in order to get it in a taxable brokerage, reducing the actual investment to $75K (or leave it at $100K and increase the 401k contributions to $125K as thd7t did. So:

401K = $125K + $625K = $750K
Taxable = $100K + $500K = $600K

By the time you retire, your investment balance is 25% higher in the 401K than it would be in the taxable account. Now it's time to withdraw and/or spend the funds. If done properly, and under the right personal circumstances, you can achieve a tax of < 15% pulling out of the 401K and 0% pulling out of the Taxable account.

Both investments will continue to grow. I'm going to ignore calculating actual amounts on that for simplicity since this is already getting much more complicated than I intended to get in this thread. Let's just say you retire at 45, and you have 25 years to move the funds. I'm going to use 20 years to allow for continued growth in the accounts during your drawdown.

401K = $750K / 20 = $37,500 * 15% = 5,625 tax
            $37,500 - 5,625 = 31,875 * 20 years = $637,500 total cash recovered

Taxable = $600K / 20 = $30,000 (This is the total investment, you don't pay tax on the principal, but you don't pay tax on the gains either if you do it right)
                $600K * 0% = $600K total cash recovered

So in this example, albeit one simplified by not calculating continued growth or actual marginal rates, and ignoring all potential deductions, exemptions, and other income that would effect your marginal rate, putting the $100K into a taxable account loses by $37,500 to putting the $125K into a 401K .

If I begin drawing down my 401K balance when I'm 45, I'll have a 14 year old, and a 10 year old at home. Married, itemized deductions, etc. With $50K in 401K withdrawals and no other income, that equates to about $20K in taxable income at most, which is just out of the 10% bracket. That means on a $50K draw, my tax would be about $2K, or 4%. If I use 4% in the example, the 401K wins by $120K.

Hopefully that will help you understand the impacts of all this Meadow, or anyone else reading. A traditional 401K/IRA/HSA etc. kicks the ass of a taxable brokerage account if you use it the way an early retiree can. Max that shit out!

thd7t

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Re: Social security taxed
« Reply #16 on: May 07, 2015, 09:25:54 AM »
This is correct, but in addition, you pay taxes at your marginal rate on your initial investment (which is only $100k, but is still at your top tax rate).  This is all really an argument about optimizing withdrawls.
EDIT: in addition, in the 25% bracket, $100k of taxable account amounts to $125k in a 401k, so when you withdraw (assuming the same exact investments), the 401k is at $725k and the taxable account is at $600k

This post confused me a bit because of the way it was worded, but I mostly agree with it after reading it a few times. Since you don't pay taxes on the initial principal when you put it in a 401k, the investment is larger than it would be in a taxable brokerage account. In the 25% bracket, you have to pay $25K in taxes in order to get it in a taxable brokerage, reducing the actual investment to $75K (or leave it at $100K and increase the 401k contributions to $125K as thd7t did. So:

401K = $125K + $625K = $750K
Taxable = $100K + $500K = $600K

By the time you retire, your investment balance is 25% higher in the 401K than it would be in the taxable account. Now it's time to withdraw and/or spend the funds. If done properly, and under the right personal circumstances, you can achieve a tax of < 15% pulling out of the 401K and 0% pulling out of the Taxable account.

Both investments will continue to grow. I'm going to ignore calculating actual amounts on that for simplicity since this is already getting much more complicated than I intended to get in this thread. Let's just say you retire at 45, and you have 25 years to move the funds. I'm going to use 20 years to allow for continued growth in the accounts during your drawdown.

401K = $750K / 20 = $37,500 * 15% = 5,625 tax
            $37,500 - 5,625 = 31,875 * 20 years = $637,500 total cash recovered

Taxable = $600K / 20 = $30,000 (This is the total investment, you don't pay tax on the principal, but you don't pay tax on the gains either if you do it right)
                $600K * 0% = $600K total cash recovered

So in this example, albeit one simplified by not calculating continued growth or actual marginal rates, and ignoring all potential deductions, exemptions, and other income that would effect your marginal rate, putting the $100K into a taxable account loses by $37,500 to putting the $125K into a 401K .

If I begin drawing down my 401K balance when I'm 45, I'll have a 14 year old, and a 10 year old at home. Married, itemized deductions, etc. With $50K in 401K withdrawals and no other income, that equates to about $20K in taxable income at most, which is just out of the 10% bracket. That means on a $50K draw, my tax would be about $2K, or 4%. If I use 4% in the example, the 401K wins by $120K.

Hopefully that will help you understand the impacts of all this Meadow, or anyone else reading. A traditional 401K/IRA/HSA etc. kicks the ass of a taxable brokerage account if you use it the way an early retiree can. Max that shit out!
Cheddar Stacker, sorry for the confusing wording.  I've bolded the parts where my bad math has gone through to your numbers.  I should have noticed that if you're taxed at 25%, your $100k costs $133k in pretax dollars!  This leads to a slightly greater ($66.5k) advantage in the 401k scenario:

401k = $133K + $666.5k = $766.5k
Taxable = $100k + $500k = $600k

My bad math on my first post propagated through.  In all, your conclusions remain spot on.