I hope this is not news to you, if it is, I hate to be the bearer of bad news, but the federal (and usually the state) government taxes your Social Security payments. What? Pay taxes on distributions from taxes I was assessed while working? Instead of moaning and groaning about it. We need to figure how best to maximize our situation.
What is the net amount of your Social Security benefit check? In other words, what do you really have to spend after income tax considerations. I take into account federal and state income tax in the SCORECARD calculations. The federal tiers were changed in 2018. Prior to that, our three retirees were in a 28% tax bracket. Beginning in 2018, their federal tax bracket is 24%. Each state has its own way of handling income tax, so you need to know your state's treatment of IRA distribution and Social Security payments to understand the impact on your net income. Our retirees all live in Iowa where their IRA distributed funds are taxed in 2017 at 8.98% (Iowa's highest tax bracket) and Social Security income is not taxed at all.
Trust me, I've done the math for the following examples! In my SCORECARD, in 2017, I assumed the net available after income taxes for the Social Security benefit was 76%. I arrived at this ratio by calculating that 28% of 85% of the payment is taxed (federal tax is applied to 85% of the Social Security income for these three) and there is no state income tax. The amount is really 23.8%. To simplify, I used 24%. This is reflected in the amount Sam has available to spend each month. For IRA withdrawals, I need to add federal tax on the remaining 15% of the amount, plus 8.98% Iowa state tax on all of it. So we add 28% of the 15% not taxed plus 8.98% of the entire amount to arrive at approximately 20.8% more needed from our IRA account to net out the same. Again, for simplicity sake, I used 21% as the added amount needed to withdraw from an IRA versus the Social Security payment. This will be reflected monthly in the amount available to Sam to spend each month. Beginning in 2018, the tax rate was reduced to 24%, so the 24% and 21% figures were reduced to 20.4% and 18.8% respectively. Starting in 2020, Iowa's top bracket is reduced to 8.53%, so I further reduce the gross amount needed from the IRA to 18.4%.
For example, for a social security payment of $1971 in 2017, the amount federally taxed was $1675.35. 28% tax on that is $469.10 for a net of $1501.90. Using a $2382 IRA distribution, federal tax is $667 and state tax is $214, for a net of $1501. Using my simplified 21% taxation impact, the amount distributed is $2384.91. This is close enough to use the simplified calculation.