Q. Would you please clarify this sentence from a recent column: "If you earn very much, however, your (Social Security) benefits become subject to income taxes." Is there a magic "earned income" number below which one does not have to pay taxes on Social Security benefits? What is that number?
Does income from other sources (pension, interest, etc.) factor into this magic number?
I was born in1943 and am trying to line up my ducks before October. —M. F., by email from San Antonio, TX
A. Whether your Social Security benefits become taxable depends on a formula rather than a specific amount.
Here’s the basic idea. When your income from other sources and ½ of Social Security exceeds $32,000 as a couple or $25,000 as a single person, your Social Security benefits cross a threshold. Some become subject to taxation.
Suppose, for example, a couple has $24,000 in Social Security benefits and $40,000 in income from a combination of interest, dividends, pension, and IRA withdrawals. According to the formula, they would subtract half of their $24,000 in benefits from $32,000 to determine how much of their other income would NOT trigger taxation of benefits. So $32,000 less $12,000 means the first $20,000 of other income has no impact on their Social Security benefit taxation.
The next $12,000 of other income will cause $6,000 of Social Security benefits to be added to their taxable income. You can thank Ronald Reagan for this.
Their remaining $8,000 of other income will cause an additional $6,800 of benefits to be subject to taxation. You can thank Bill Clinton for this.
As a result, the couple would have a taxable income of $40,000 plus $12,800 in Social Security benefits, or $52,800— instead of $40,000.
The greater your Social Security benefits, the smaller the amount of other income you can have before you pay taxes on your benefits.
As you can see, this is a complicated business (send another bipartisan thank-you to Congress). Fortunately, you can use an online calculator to figure the amount of your benefits that will be subject to taxation. One is on the Smart Money website at http://www.smartmoney.com/personal-finance/taxes/will-your-social-security-benefits-be-taxed-again-21987/
After that, it’s a good idea to visit with your accountant.
Q. I manage my mother-in-law’s retirement income. Currently she receives $30,000 a year from the Texas Teachers Retirement System and $11,000 from investment-grade bonds and to a lesser extent, master limited partnerships (worth about $160,000 at par value). She sold her house and will be receiving $150,000 cash. She is 72. I am seeking guidance for an investment plan on this $150,000. Her total expenses, in a retirement community where she now lives, are about $47,000 a year (50% of her living expenses are fixed). It has been suggested to me that I should consider the Vanguard GNMA fund. Do you agree, or should I be considering something else? She has no other debt or assets to consider.— B.F., by email from Houston, TX
A. If her total expenses include her income taxes, then she’s short about $6,000 a year. This represents about a 4 percent yield on her $150,000 home sale proceeds. Vanguard GNMA fund is a good choice. While it has minor ups and downs, it has routinely produced an interest yield well over 4 percent. If you visit the Morningstar website, you’ll find that Vanguard GNMA (Ticker: VFIIX) has been in the top 20 percent of its peer group for time periods out to 15 years.
Unfortunately, your mother-in-law has almost no provision for possible capital growth, so it might be a good idea to take advantage of this bear market and make some commitments to equities, either directly, through a balanced fund, or through a combination. Vanguard Wellesley (ticker: VWINX) is a conservative allocation fund — meaning that it is more fixed-income than equities—with a current income yield over 5 percent and a 5-star rating from Morningstar. You could also mix a combination of Vanguard Total Market ETF, Vanguard GNMA, and a REIT index fund. This would produce a yield nicely over 5 percent.