Cruel ‘tax torpedo’ delivers a sting

The reader was upset. He didn’t know it yet, but the “tax torpedo” had just hit his retirement. That’s the name I gave the taxation of Social Security benefits in 2003. His note asked if there was some mistake in his income tax calculations. If he took an extra $1,000 from his IRA account, it was taxed more than he expected. But if he took another $20,000, the additional tax wasn’t so painful. No matter what, his tax bill was a lot higher than he expected.

In the early 1980s, the Social Security system was running short on cash. A commission recommended increasing the retirement age over a long period and increasing the Social Security portion of the employment tax.

Social Security benefits would also be taxed. Result: Few paid the tax then, but it hits many retirees today, with more expected. Use an online calculator on the Smart Asset website to see how this will affect you.

The average retirement benefit is $1,346.72 a month. Two average workers who are married would have combined benefits of $32,321 a year — all tax-free. They can take another $19,000 from their retirement accounts and still pay nothing in taxes.

As total income exceeds $51,321, the first tax bill appears, $138. There would be no tax if Social Security benefits were not part of the calculation.

On the next $12,000 of additional income, the couple pays $150 on each $1,000, a 15 percent tax rate. After other income exceeds $32,000, their tax rate jumps to 27.7 percent.

When benefits are taxed, tax bills then double. If other income is $33,000, taxation of benefits jumps from $1,230 to $2,475.

For single taxpayers, a retiree with benefits of $16,161 can have an additional income of $17,000 before there is a tax difference over not having benefits subject to taxation. At $20,000 in other income, he or she will pay $1,215 in taxes with taxation of benefits, compared with $984 if benefits weren’t taxed. With other income of $30,000 a year, the tax bill will be $3,679 compared with $2,484, almost 50 percent more.

Congress can start helping the middle class by repealing the taxation of Social Security benefits.

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