One of the most important decisions you’ll make about your retirement is when and how to receive your Social Security benefits, but it’s crucial to understand potential tax implication prior to doing so.
For many retirees that will have additional sources of income in retirement, Social Security benefits can push you into a higher tax bracket. However, with the proper proactive planning, you can create a strategy that will leave more money in your hands, and less in Uncle Sam’s. Having an idea of just how much your Social Security checks will be worth can help you create a tax-efficient income plan for retirement.
How many years have you worked?
- The Social Security Administration uses 35 years of earning history
- If you worked more than 35 years, it uses the highest of 35 years of salary.
- If you worked less than 35 years, it still uses 35 years of salary (the years you didn’t work count as $0).
How much have you earned in each year?
- In 2017, the maximum amount of earnings that is subject to Social Security taxes is $127,000.
- Once you turn age 62, the SSA will apply an indexing factor to your years of earning history in order to account for inflation.
- If you work beyond age 62, earnings in those years will be counted at their nominal, non- inflation-adjusted amounts.
- Your highest 35 years of inflation-adjusting earnings are averaged and divided by 12 to get your average indexed monthly earnings (AIME). The highest possible AIME for 2017 is $9,784.
- After AIME calculation, certain bend points are applied to determine your ultimate primary insurance amount (PIA)—the amount you are entitled to at your full retirement age (FRA).
When Do You Claim Benefits?
- Your PIA is a starting point, telling you what you would get if you began receiving benefits at FRA – age 66 if you were born between 1943 and 1954. If you were born after 1954, check with the SSA to determine your FRA.
- If you choose to receive your Social Security benefit at age 62, it will be reduced for life equal to 5/9 of 1% per month (6.67% per year) for the first 36 months claimed prior to FRA and 5/12 of 1% (5% per year) for each additional month.
- For each month you delay benefits beyond your FRA, your benefit will increase by 8/12 of 1%, or at a rate of 8% per year. These are known as delayed credits.
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