Things are even harder to figure out for people who are retired, receiving Social Security, and working full or part-time. Most retirees don’t have a clear understanding of how much they are taxed on job income they receive from post-retirement employment.
Reduction of Social Security Benefits
If you reach full retirement age during 2009, the government will deduct $1 from your benefits for each $3 you earn above $37,680 until the month you reach full retirement age.
I explained in an earlier post that the benefit reduction is returned to you in an increased benefit after you reach full retirement age.
Taxation of Social Security Benefits
The second “whammy” from working after retirement is that, depending on how much you make, some of your Social Security benefit can become taxable.
These are the current tax rules:
If you file a your federal tax return as an individual, and your combined income is:
- between $25,000 and $34,000, you may have to pay income tax on 50 percent of your benefits.
- more than $34,000, up to 85 percent of your benefits may be taxable.
If you file a joint tax return, and you and your spouse have a combined income that is
- between $32,000 and $44,000, you may have to pay income tax on 50 percent of your benefits
- more than $44,000, up to 85 percent of your benefits may be taxable.
Your “combined income” is the sum of your adjusted gross income + 1/2 of your Social Security benefits + any non-taxable interest received.
Adding it All Up
Now that we know the rules, let’s add all of those taxes up:
Assume that you are single, have reached full retirement age, that you are receiving $25,000 per year in Social Security benefits, and working a full or part-time job that pays you $30,000 annually.
Your “combined income” is $12,500 (1/2 of your benefit) plus $30,000 in AGI = $42,500.
Now instead of being taxed just on the $30,000 wage income at a 15% marginal tax rate, you are also paying taxes on $12,500 of Social Security income.
This effectively increases your taxes on your last wage dollars earned by 7.5% because those wage dollars cause 1/2 of your Social Security dollars to be also taxed at a 15% marginal rate. So now your effective marginal rate on those wages has increased from 15% to to 22.5%.
But wait – we are not done.
Don’t forget that you are also paying Social Security and Medicare taxes on those wages. That rate is approximately 7.5%. So now you – a Social Security retiree – are surrendering approximately 30% of your wage dollars to the government.
But wait – we are still not done!
Let’s assume that you are like a lot of baby boomers and working part-time consulting gigs or are otherwise self-employed. This means that you also have to pay the employer’s share of the payroll taxes, i.e., another 7.5%.
Adding it all up, your effective marginal tax rate on your post-retirement job income could be 37.5%!
Kind of scary and upsetting – don’t you think?