Friday, June 19, 2009
Questions on tax deferrals and taxing social security benefits: a misleading concept, maybe
I got an email this morning asking whether someone who earns both social security and other income can defer some of the tax on “social security income” (it gets complicated, remember – it can get up to 85%) by continuing to contribute to an IRA.
Let me remind readers, go to a tax adviser or attorney for a definitive answer on your individual situation. All I can do is provide the references to the rules, which can be complicated.
The IRS publication relevant to this question seems to be 915, with a PDF online at the following URL. With any question like this, always go to the original federal government publication if possible.
Note particularly the preliminary questionnaire on p 3, and then the worksheet on p 7. I don’t see anything about contributions to an IRA or similar plan from coincidental wages. There is mention of items like savings bond interest and adoption benefits being added in.
If you work, you can tax-defer up to a certain maximum of your wages (but not pension, investment, or social security benefits themselves) in an IRA, and the maximum increases at age 55.
I guess the short answer seems to be “yes and no”. It doesn’t look as thought the IRS considers IRA contributions in computing taxability of social security benefits, because you can defer only wages. But your total tax bill will or may still be substantially less if you work and defer some of your wages. So it sounds like a matter of semantics.
MSN Money Central covers this problem here.
Remember that Social Security applies an Annual Earnings Test until you reach full retirement age. It looks like I covered the rules for this concept on Feb. 27, 2006 on this blog. Here is the URL for the social security’s own rules, in baby talk, again. I don’t see anything there about deferring taxes on benefits. After full retirement, your benefits may increase over what they would have been if some were deferred because of the Annual Earnings Test.
As a general rule, it’s better to work if you can, and tax the tax deferral as allowed by law or IRS rules on part of your wages. You’ll come out ahead in the end that way. More people are having to work longer given increased life spans, family responsibility, and the recession.