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Losing Benefits

Richard Connor

SOCIAL SECURITY retirement benefits are a critical source of income for many seniors. But as I’ve discovered from preparing tax returns, there’s a lot of confusion surrounding two key issues.

The first issue: the reduction in benefits that occurs when folks claim benefits before their full retirement age (FRA) of 66 or 67, but continue to work. This is the so-called earnings test. If folks are under their FRA for the full year, the Social Security Administration will reduce their benefits by $1 for every $2 earned above $22,320, which is the earnings limit for 2024.

Suppose you earned $42,320, or $20,000 above the earnings limit. Your Social Security benefit would be reduced by $10,000. The maximum Social Security benefit for 2024 is $58,476. To lose this entire sum, you’d have to earn twice this amount, or $116,952, plus the earnings limit of $22,320, for a total of $139,272 in 2024.

In the year you reach your FRA, the earnings limit is significantly higher—it’s set at $59,520 for 2024—plus the reduction in benefits is $1 for every $3 earned above this limit. What happens once you get to your FRA? There’s no reduction in benefits, regardless of how much you earn. On top of that, once you reach your FRA, Social Security recalculates your monthly check, so you get credit for the benefits you earlier lost.

The second confusing topic: the taxation of Social Security benefits. Whether your retirement benefits are partially taxable depends on your combined income. What’s that? It’s your adjusted gross income, plus any non-taxable interest and half of your Social Security benefits. For a single person, if your combined annual income is less than $25,000, none of your Social Security benefits is taxable. Between $25,000 and $34,000, up to 50% of benefits are taxable. If your combined income is more than $34,000, up to 85% of benefits are taxable.

I was reminded of all this recently when I prepared a tax return while volunteering with AARP’s Tax-Aide program. Robert’s tax return stuck in my head for a few reasons. First, we shared a birthday, although—at age 68—he’s two years older than me. Second, his return is likely the simplest I’ll do this season.

He had one document, a 1099-SSA that reported his Social Security benefits. His benefit in 2023 was $33,050. From this, $1,979 was subtracted for his Medicare Part B benefits and $3,900 for alimony from a 1999 divorce. His net benefit was $27,171.

When I asked if he had any other sources of income, he said things were tough. He’d been on Social Security disability benefits for a number of years. When he reached his full retirement age two years ago, Social Security switched him over from disability benefits to retirement benefits.

Robert’s return only took a few minutes to prepare, but he had some questions. He was considering getting a job to supplement his income, but he’d heard that if he made too much it would reduce his benefit. We explained that, since he was past his FRA, his Social Security benefit would not be reduced based on earned income.

We then discussed the taxation of his benefits should he choose to work. He was aware that earned income could cause some or all of his benefits to be taxable, but wasn’t sure how much he could earn without a significant tax hit. For 2024, Robert’s standard deduction will be $16,450, comprised of the typical $14,600 standard deduction, plus $1,950 since he’s over 65. The sum of his earned income and any taxable Social Security benefits would have to exceed this amount before he’d owe federal income taxes.

Since Robert’s only income in 2023 was his Social Security benefits, his combined income was one-half of this, or some $16,500. This means he could have earned $8,500 before he’d have hit the $25,000 limit at which Social Security benefits become potentially taxable. And even if he surpassed this limit, he wouldn’t necessarily owe income taxes, thanks to the added tax relief offered by the standard deduction.

Because of the complexity of many tax code provisions, and the way they interact with each other, often generating a sample tax return is the only way to see how a change in one variable, like earned income, impacts a taxpayer’s final tax bill. This can be especially true when a person’s state taxes are as complicated as New Jersey’s.

The tax software we use made it easy to run a series of “what if” scenarios to see how various levels of earned income would impact Robert’s taxes. The calculations were based on 2023’s tax law. One of the thoughts I had was that Robert might be eligible for the earned income tax credit (EITC).

At low incomes, a single filer with no qualifying children could be eligible for a credit of up to $600. Robert wouldn’t be eligible for this federal credit because he’s older than the age 65 cutoff. But New Jersey provides a credit that’s equal to 40% of the federal amount and there’s no maximum age, so Robert could have earned $8,500 without owing anything in federal or state income taxes, plus he’d have been eligible for a $240 state EITC.

True, Robert would have paid $667 in Social Security and Medicare payroll taxes on the $8,500 of earned income. Still, with the state EITC credit, he would’ve netted $8,063 out of the $8,500. None of his Social Security benefits would be taxable. The additional income would represent a 30% increase in his standard of living. In fact, Robert could have earned $10,000 and still received New Jersey’s EITC, while paying no federal or state income taxes.

The table below summarizes Robert’s tax situation, and how various levels of income would affect his tax return. It shows that, for low-income retirees, a modest amount of income can dramatically increase their standard of living without significantly boosting their tax bill.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on X @RConnor609 and check out his earlier articles.

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