Jason and Emilia discuss taxes and social security.

Below is the full transcript:


Announcer: Welcome back America to Sound Retirement Radio where we bring you concepts, ideas, and strategies designed to help you achieve clarity, confidence, and freedom as you prepare for and transition to retirement. And now, here is your host, Jason Parker.

 Jason: Welcome back America to another round of Sound Retirement Radio. As always, I sure appreciate you tuning in to our program. I want to remind you that you can find all of these past episodes, or all of the episodes, online at SoundRetirementRadio.com. Actually I’ve been doing the program now for a little over seven years, and I think we only have about 2 years worth of programs archived for your listening enjoyment because I know you just can’t get enough of my voice. I know I can’t get enough of my voice. That’s why I’m always talking to myself. My dad used to say, “Jason, it’s okay to talk to yourself as long as you never say ‘huh’.”

Emilia: Huh.

 Jason: I’ve got Emilia Bernal in the studio with me today, and I’m excited to be bringing you episode 079. We’re going to be talking about taxes and Social Security, everybody’s two favorite subjects. Before we get too into that, I want to start with a verse to renew our minds this morning. Here it is. This comes to us from Hebrews 13:7. “Remember your leaders who spoke the word of God to you. Consider the outcome of their way of life and imitate their faith.”

Gosh, I love that, Emilia. In fact just today I had the opportunity over lunch to ask some people, some good friends of mine, who their mentors were. Who were people of faith in their life that really impacted that path that they went down? It was really kind of fun to see people and hear who those stories were. Oftentimes it related back all the way to when they were like 6, 7 years old. Maybe a Sunday school teacher or something.

Emilia: Wow.

 Jason: Yeah. For those people that are out there doing good work, sharing a good word with folks, the Good Word I should say; you never know what impact that’s going to have on people’s lives. Thank you, keep it up. The next thing I want to do since we’re going to be talking about taxes, I have a joke here. This is from Mark Twain. He says, “What’s the difference between a taxidermist and a tax collector? The taxidermist takes only your skin.” There’s one more here. “What’s the difference between a tax auditor and a rottweiler? A rottweiler eventually lets go.”

Emilia: Oh, wow.

 Jason: Now, I have some clients that work for the IRS, so I don’t want to get too carried away here. Okay, so where are we going with this show this morning?

Emilia: As you mentioned, we’re going to talk about taxes and Social Security today. Before we do that, I would like to remind our listeners that we’re going to be holding a webinar on Wednesday, January 20th at 5:30pm. For those of you that would like to register, please visit SoundRetirementPlanning.com, and there’s a bright orange box on the right hand side that they can use to register for that webinar.

 Jason: Yeah, it should be a good time. We’re going to cover a lot of things. One of the things that’s really important to people right now is this new law that took place on November 2nd that changed some of the claiming strategies that are available, especially for married couples. We’re going to get into depth on that, talk about some of the best Social Security calculators out there, and look at some of these little nuances that people should be thinking about if they are getting ready for retirement and they’re going to plan on using Social Security to help supplement their income. I’m looking forward to that.

Emilia: Great deal. I just wanted to start off. You’ve been talking a lot about taxes. Why is that?

 Jason: You know, taxes, taxes, it’s everybody’s favorite subject. It’s because … Well, let me give you a little bit of background and history on this before we talk too much. I went back through the tax archives, if you will, to help understand the top tax rates over time. The top marginal tax rates over time. In 1936, the top tax rate was 79%. In 1954, the top tax rate was 91%. The year that the 401K became available, 1978, the top tax rate was 70%. The year that Ronald Reagan took office, 1981, the top tax rate was 70%.

Now, here’s what’s interesting. By the time Ronald Reagan left office, in 1989, 8 years later, the top tax rate was 28%. Bill Clinton left office in 2001. By the time he left office, the top tax rate was up to 39%. By the time George Bush left office in 2000 … or no, I’m sorry. Yeah. Well, George W. Bush I should say, the top tax rate was 35%. Now, President Obama is getting ready to leave office in 2016, and the top tax rate is 39.6%.

It’s interesting to look back historically over taxes. Now, when you take into consideration where we’re at with our national debt, our national debt is quickly approaching $19 trillion, $19 trillion.

Emilia: Wow.

 Jason: It was interesting to go back to the year 2008, 8 years ago, when we looked at the national debt. The national debt was $9.5 trillion, so we have doubled the amount of money that we owe people in 8 years. I really think that’s important to understand, because in the latest State of the Union Address by President Obama, he talked about the fact that the deficit was reduced, which was a true statement. The difference between deficit and debt is deficit is looking at the amount of tax revenue that is coming in versus how much we’re spending. A deficit means we are spending less than the tax revenue coming in. But our national debt, he didn’t address at all.

I take a little bit of an issue with that, because I feel like it’s deceptive. People hear deficit, they hear debt; they don’t really understand what the difference is. I really think it’s important to understand that our debt, the amount of money that we owe, has doubled in 8 years; from $9.5 trillion to $18.8 trillion.

When I talk about taxes … Emilia, you know this, you’re on many of the speaking engagements that we do locally here. One of the questions that I’ll always ask people … I’ll say, “Look folks, we’ve got 10,000 baby boomers retiring every single day in our country, we have this new Affordable Health Care that’s even creating more of a …” We’re spending more on healthcare than we ever have. All these baby boomers are transitioning into Medicare, which is putting more of a strain on that program, so you’ve got Social Security, Medicare, and the question becomes … We already have a debt of $19 trillion, how long can we continue to run up this debt before our lenders come to us and say, “Hey, we’re not going to lend you money anymore.”?

Then, if you look back historically at the top tax rates and you say, “Man, they’ve been 79%, 91%; and right now the top tax rate is only 39%.” When I ask a group of people, and we do this all the time, I’ll ask for a show of hands. “How many of you think tax rates are going to be going lower in the future?” Nobody raises their hand.

Emilia: Yeah, they all think they’re going up.

 Jason: Yeah, and I think it’s a pretty logical assumption. You can’t run a deficit forever. If you’re living in your house, you can’t just continue to put money on a credit card and think that that’s never going to catch up with you just because you keep flipping from one credit card to the next credit card, rolling over the debt. I mean eventually you know one of those credit card companies, they’re going to want to get paid.

Emilia: Exactly.

 Jason: That’s the same thing with our national debt, so it’s really an important topic. It’s especially important though, as people transition into retirement; because when you’re putting together a retirement plan … Retirement is all about cash flow; it’s your income that will determine your lifestyle in retirement, not your net worth. We want to make sure that you understand the implications that your tax obligations are going to have on that cash flow. Because if you’re making a projection that you’re going to be in a 15% tax bracket in retirement, and you end up in a 25% tax bracket in  retirement; well, that’s one of those stress points. That’s public policy risk that could shorten the length of time that your money is going to last. That’s why taxes are so important, and that’s why I wanted to talk specifically about that this morning.

Emilia: Well, that’s great. Talking about taxes, why do you talk about Social Security being tax-efficient?

 Jason: It really is tax-efficient. The bottom line is this. In a worst case scenario, when you receive a dollar from Social Security, the very most that you have to count as income is 85 cents. You compare that with something like a retirement account, a lot of people have 401K’s or 403B’s or TSP’s or TSA’s. Every dollar, just about in most instances, you know depending on how they contributed; but for most people when they take a dollar out of a retirement account, that’s what we consider tax-hostile money. Because it’s all taxed at ordinary income.

You take a dollar out of your traditional IRA, it’s going to be taxed as a dollar in most instances. You take a dollar from Social Security and only 85 cents of it is taxable, in a worst case scenario. We oftentimes see scenarios and situations where people are paying less than 85 cents on every dollar from Social Security. Understanding how to coordinate income can really impact the amount of Social Security that is taxable.

Emilia: Isn’t income, income; or doesn’t it all get taxed the same?

 Jason: No, income is not income.

Emilia: Okay.

 Jason: There’s a lot of different moving parts. I like to break income down into three different types. You’ve got ordinary income, that’s going to be taxed. That’s your most tax-hostile money. You have tax-efficient income, that’s going to be things like Social Security. Then you have tax-free income. At most of the opportunities that I have to speak, that’s everybody’s favorite; tax-free.

Emilia: Mine too.

 Jason: Now, tax-free income really comes in two flavors, for the most part. You’ve got municipal bond interest income. In most instances, is going to be tax-free. Then you also have Roth IRA distributions from a qualified account. Assuming that you’ve met all the rules for the Roth IRA, when you pull that money back out, it’s going to be tax-free. That’s actually my favorite form of tax-free income, it’s the Roth IRA income.

Because of that, one of the planning opportunities people need to be thinking about is potentially converting some money to Roth IRA’s; or contributing to Roth IRA’s, diversifying future tax obligations. Maybe laying off on the traditional IRA contributions and making more of a contribution to a Roth IRA.

Emilia: Great. That’s a lot of information. I’m sure you’re probably going to cover some of that in your webinar as well.

 Jason: Absolutely, yeah. There’s a couple of case examples I like to share with people about ways to … When they are thinking about when to start Social Security versus taking income from IRA’s, it’s a concept that’s popular. It’s a popular concept known as the tax torpedo.

Emilia: Oh, interesting. Torpedo. How does Social Security determine what your provisional income is?

 Jason: You know, this is one of those areas where we can really lose people quickly, because it is not as straight forward, provisional income. Basically what Social Security says is, depending on whether or not you’re single or married, up to a certain threshold, a certain amount of your Social Security is going to be taxable. Provisional income is basically … It includes one half of your Social Security benefits; so if you’re receiving say $30,000 a year in Social Security, it would be half of that. $15,000 is counted towards provisional income. Plus all other taxable income, including dividends, realized interest (I want to underscore realized interest), and realized capital gains, plus non-taxable interest earnings, such as from municipal bonds.

This is one of those areas where municipal bonds actually count against your provisional income [rule 00:12:39]. Even though it’s tax-free income, you still have to count it when trying to determine how much of your Social Security income is taxable. Compare and contrast that with a Roth IRA, and income from a Roth IRA is not counted towards that provisional income formula. That’s why I say I prefer the Roth IRA, because it’s truly tax-free and it has no negative impact on how much of your Social Security is taxable.

Emilia: Well, that’s great to know. Again, I want to remind our listeners that Jason is holding a webinar this Wednesday, January 20th at 5:30 pm. If you would like to register, please visit SoundRetirementPlanning.com, and click on the bright orange box on the right hand side of the page.

I do have a couple of more questions that I’d like to go over, though. What are some ways that people might be able to reduce the taxation of their Social Security?

 Jason: Yeah. Two of the simplest ways that most people need to be looking at is number one … I see a lot of times really conservative investors, or savers I should say, will have money in bank certificates of deposit. Every year, on those back CD’s … Emilia, do you know what CD stands for?

Emilia: Certificate of Deposit.

 Jason: Certificate of Disappointment, that’s what.

That’s absolutely right. On those certificates of deposit, they get a 1099 Interest Income statement every year at the end of the year, even if they don’t spend that interest. We see this all the time. I’ve seen people that come in, they have a million dollars in bank CD’s; and that’s producing taxable income for them that they’re not spending. We always tell people that if they’re spending the income, well that’s a good thing; but if you have income that’s hitting the front page of your tax return that you’re not spending.

That’s why I wanted to point out, I said, “realized interest”. It’s possible to use a tax-deferred vehicle, that defers that interest into the future, and then you don’t have to count that toward your provisional income. For example, savings bonds can be tax-deferred. Fixed deferred annuity contracts issued by insurance companies can be tax-deferred, as long as you don’t pull the interest income out of them in any one year. That’s one really small way, that we see all the time, where people can reduce the amount of taxes that they’re paying, and oftentimes when you … Somebody once told me, they said, “Jason, a very small hinge swings a great big door.”

Emilia: True.

 Jason: When it comes to your tax return, it couldn’t be more true; because what happens is anytime something changes on your tax return, it filters through and it impacts a lot of the different moving pieces. Provisional income is a big one, so anytime you can reduce the amount of 1099 interest income that you have, if you’re not spending that interest income, then that’s one really great opportunity.

Emilia: Wow. That’s good to know. What are some strategies people might want to consider from a tax standpoint as it pertains to Social Security, which is what you just talked about, correct?

 Jason: Yes.

Emilia: Okay, so what is the biggest mistake people make when electing Social Security?

 Jason: Well, first of all, let me back up. When it comes to Social Security, one of the things I think people should be thinking about is when they should start it, when they should start their Social Security. Because Social Security is tax-efficient income, meaning that in a worst case scenario, only 85 cents of every dollar gets taxed, it may make more sense for some people to consider taking distributions from their IRA’s the first several years of retirement.

If we continue to be in these all time, historically low marginal income tax rates, like we’re in right now … I mean if you can take a distribution from your IRA … Let’s say your retire at 62, and so instead of starting Social Security, you take a withdrawal from your IRA. We allow your Social Security to continue to grow. Most people know that after full retirement age, you earn 8% delayed retirement credits all the way up until age 70; if you let that benefit grow. We let the Social Security benefit grow all the way up to age 70, we take out distributions from IRA’s or Roth IRA’s in the early years, where we can have some control over the tax liability; but also at a time when tax rates are really low. Then we turn that Social Security income on at age 70, we stop taking those big distributions from the IRA’s, and all of a sudden we can create a really tax-efficient type of scenario for somebody. Now, that doesn’t always work to be the best, but that’s something that people should be thinking about.

The second question … What was the second question that you had there?

Emilia: What was the biggest mistake people make [crosstalk 00:17:40]?

 Jason: Well, the biggest mistake, and it’s getting back to this idea that you shouldn’t make a decision on Social Security in a vacuum or a bubble. You should take into consideration all of the different things that people need to be thinking about. They should be thinking about a retirement cash flow plan that should take into consideration any pensions they have, any other retirement income sources. Are they going to have a lot of itemized deductions in their early years, and not so many in the later years? Maybe they’re still paying off a mortgage, and they’re getting to itemize some of that interest expense. A good retirement cash flow plan wants to incorporate Social Security, but probably the biggest mistake I see is that people go out and they make a decision about Social Security without having any retirement plan. That’s a mistake.

The thing I’ll always warn people of too, is we can make some assumptions about Social Security. How it works today, and hope that it’s still going to work that way in the future; such as the taxation of Social Security. The reality is, if we look back historically; originally when Social Security was first started, it wasn’t taxable income at all.

Emilia: Interesting.

 Jason: Yeah, it was under Ronald Reagan’s administration that Social Security became taxable for the first time ever, up to 50% of your benefit could be taxable. That happened under Ronald Reagan’s administration, who is generally known as a pretty tax-friendly president. It was under Bill Clinton, as president, his administration; that the taxation of Social Security increased to up to 85% of Social Security could be taxable. While it is a tax-efficient income stream today, Congress could change the rules.

Given the budget deal that we just saw happen on November 2, 2015 that really changed the Social Security claiming rules for married couples, it wouldn’t surprise me one bit if in the future, Congress comes along and says, “Hey, every dollar that you get from Social Security is now taxable to you.” Like I say, we’ve got $19 trillion of debt. I don’t think it’s a very popular move, but it’s certainly a possibility.

Emilia: It sounds like these changes, like you said, can take place at any time; and we just need to be planning ahead.

 Jason: Absolutely. I wanted to hit on the bullet points that we have coming up for our webinar.

Emilia: Yes.

 Jason: Here are couple of things you are going to learn. First of all, how to maximize your Social Security retirement income using the best free Social Security calculator. The next one is why some high net worth couples may be better off starting benefits as early as age 62. The next thing we’re going to talk about is why Social Security income is tax-efficient, especially when compared to IRA or 401K income; continuing on with kind of the topic of this morning.

We’re going to talk about how to coordinate retirement income and avoid common mistakes. Very important, especially for widows and married couples I would say, coordinating those benefits. We’re going to ask the question, “Should you be concerned about the recent Social Security trustees report that basically shows that Social Security is only going to be able to pay 77 cents on the dollar by the year 2032?” Looking at if that happens, what’s the impact and should you have a backup plan in place? I’m the kind of guy, I like to have backup plans in place.

Emilia: Yes.

 Jason: Then finally, probably the big one, is we’re going to understand how the new law that passed on November 2, 2015 is going to impact people’s claiming strategies; and there’s a deadline that people … I really want to get this point across. If you are currently full retirement age, or you’re going to be turning full retirement age within the next couple of months, this is so important. One of the strategies that we used to use, called file and suspend, was eliminated on November 2, 2015; but they’re allowing people to still do it if they are full retirement age until the end of April, April 30th.

What that means is that if you are currently full retirement age, even if you are not ready to start Social Security yet, there may be a planning opportunity for us to capture that’s going to be permanently gone after April 30th. If any of our listeners are driving down the road this morning in the Seattle area, or maybe you are listening to the podcast from around the country; I want you, especially those people, to visit SoundRetirementPlanning.com and click the link that says to talk to me, so that we can give them some guidance on the best way to make a decision on Social Security before that door completely, permanently closes.

Emilia: Definitely. It’s kind of like a reminder, April 15th for taxes; and now it’s April 30th, officially, for the Social Security. Keep that in mind.

 Jason: You know opportunities, you’ve got to capture them when they’re there. It’s not that hard to do, but a lot of people don’t even know that this is happening. A lot of people are going to call me in May or June and say, “Jason, I wish I would have known about this back then.” I’m going to say, “Me too.” Not only listeners do I want you to take action on this, but if you know anybody that’s in this situation, have them listen to this program; because these are all archived online at SoundRetirementRadio.com. Or just tell them to schedule a quick 15 minute phone call so we can give them some guidance.

Emilia: Yes. All right. I think I’ve covered all my questions for today. Again just a reminder to our listeners, I want to make sure that we remind you of our webinar scheduled for Wednesday, January 20th at 5:30pm.

 Jason: That’s right. We’re going to have a webinar, we’re going to be talking about Social Security, we’re going to be talking about how to maximize benefits, we’re going to be talking about how to coordinated benefits, we’re going to be talking about the taxation of the benefits. We’re going to be talking about some really great calculators, free calculators. I’ve looked at a lot of them. The one that I use … You know we pay a fair amount of money to have access to what I think is the absolute best calculator out there from a planning standpoint, but there are some free calculators too for people that are more of a do-it-yourself kind of person, so we’re going to point them in that direction as well.

Emilia, thank you so much for helping me with Sound Retirement Radio today.

Emilia: Of course, thanks for having me.

 Jason: Okay. This is Jason Parker signing out until next week, folks.

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Jason Parker is the president of Parker Financial, an independent fee-based wealth management firm located at 9057 Washington Avenue Northwest, Silverdale, Washington.

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