Taxation of Social Security Benefits
Just because your Social Security income is coming from the government, don't assume the government won't want some of it back! For many people, at least some of their Social Security benefits will be subject to taxes.
The IRS makes a distinction between two types of income for tax purposes. Earned income is all the income you get from working, including any wages you make as an employee or any net earnings from self-employment. Unearned income includes investment interest, capital gains, and dividends.
In 1984, Social Security benefits became taxable if you had yearly income that exceeded certain limits. Retirement plan distributions can lead to higher taxes on your Social Security benefits as well, by pushing you over those limits.
If your income, prior to retirement plan distributions, already has you paying maximum tax on Social Security, then the distributions will not make it worse. However, if you live on income below $25,000 ($32,000 for married, filing jointly), then you should consider the effect of taking distributions from your retirement accounts.
If you are below normal (or "full") retirement age, but have begun drawing Social Security benefits while still working, there is a factor to consider in addition to taxation: there is a limit to how much you can earn without decreasing your Social Security benefits. Here is how it works:
Normal retirement age varies from age 65 to age 67, according to your year of birth. (The Social Security Administration has a handy online chart and calculator.) Persons born in 1943, for example, turn 65 in 2008. They have a normal retirement age of 65 years and six months. (Retirement before "normal retirement age" is allowed as early as age 62, but with a substantial reduction in benefits. Retirement after this age increases benefits, up to age 70.)
If you are below normal retirement age for all of 2008, you lose $1 in benefits for each $2 you earned above $13,560. If you reached normal retirement age during 2008, your Social Security benefits will be reduced by $1 for each $3 you earned above $36,120.
Starting in the month you reach normal retirement age, you will begin receiving full benefits for the rest of your life, no matter how much you earn. These benefits may still be taxable, however.
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