Q. Would you please explain what happens when one reaches the age of 70 1/2? I participated in 401(k) investments when I was employed, but no one prepared me for what would happen when I reached 70 1/2. I was led to believe that I would be in a different income tax bracket when I retired, so I would pay less in taxes. They never mentioned that Social Security benefits might be affected. We are paying taxes on 85 percent of our Social Security benefits. Knowing what I know now, I'm not so sure that I would have taken the same route. After the Required Minimum Distribution is added, we are in another tax bracket. ?—S.R., Richardson, TX
A. You're not the only person who has been blind-sided by the taxation of Social Security benefits. The tax was the brainchild of David Stockman. He was the Director of the Office of Management and Budget during the Reagan administration. He slipped this little time bomb into the Social Security reforms that were adopted in 1983.
It was a time bomb because the formula is one of the few parts of our entire tax code that is not indexed to inflation. As a result, very few people were affected in 1984, but many people are being affected in 2013. It will affect future retirees— your children and grandchildren— still more.
According to the 2013 Social Security Trustees report, for instance, the taxation of benefits brought only $2.8 billion back to Social Security in 1984. But last year the tax yield was nearly ten times as much, $26.7 billion. The greater the rate of inflation, the greater the number of retirees affected.
Making up to 85 percent of your Social Security benefits taxable income increases your tax liability in two ways. First, it increases the amount of income subject to tax. Second, it increases the average tax rate that you pay on your income.
The only good news here is that no more than 85 percent of your Social Security benefits can be added to your taxable income. Once that has happened, the burden is done— except that the unexpected additional income may have moved you into a higher tax bracket, one that you didn’t expect when you retired. But if you are paying taxes on 85 percent of your benefits now, you won't be burdened with an additional Social Security benefits tax in the future as your Required Minimum Distribution increases.
Q. My wife and I are 67 years old. We have sufficient assets to live comfortably through any likely events. We own our home. We have no debt. We have wills, powers of attorney, and medical directives. I have always handled our bill paying and financial affairs. I have tried showing my wife how to do it, but she is not interested and has no aptitude for it. Reconciling a monthly bank statement baffles her. We have no children or close relatives. We are in good health now, but what happens if I get dementia or die? My wife would need help writing checks, making income tax deposits, and handling banking. Are there people who provide this kind of service for a fee? —L.V., by email ?
A. I suggest that you start exploring your options by doing a web search on "bill paying services for seniors." If you select one now you can have some confidence that it will operate properly when something happens to you.
That, however, won't eliminate your wife's vulnerability to the countless venders of financial products. Many sales people prey on recent widows who have no financial experience.
To reduce that risk I suggest that you simplify your investments as much as possible by reducing the number of holdings and consolidating. In an ideally simplified plan, you would have your financial assets reduced to a single broadly diversified balanced fund. Your wife can then arrange for a single annual distribution from that fund to her checking account every year. You should also consider having some part of your financial assets used to purchase a single life annuity for your wife upon your death or disability.
You might also consider talking to your wife about how her reluctance to take on any of these adult responsibilities makes her a victim-in-waiting.