Video Posted: Jul 16, 2025
This is John Smallwood, and I want to welcome you back to the Money Isn’t podcast. Today, I’m going to be diving into the concept of Social Security taxation.
When Social Security first came out, all of the income that somebody would receive from Social Security was tax-free. It wasn’t till much later on where certain income thresholds would cause it from not being taxed to having 85% of the benefit taxed. So there’s this cliff of income that you can have, and once your income crosses over a certain threshold, you end up going from not paying any tax on Social Security to paying tax on 85% of it. So proper planning comes into play here, but I want you to understand the strategy.
I think visuals are great. I think conversation is great. I think visuals and conversation combined together is even better. So what I have here is a concept of a husband and wife. They’re 68 years old. The husband has $4,100 monthly Social Security, and the wife has $2,000. And they have $1,000,000 in a retirement plan and a house paid for, for $600,000. Simple, easy concept. And they’re not taking a distribution right now from their IRA, and they have no money elsewhere. So there’s no dividends, there’s no interest.
And in this model, as you look at this, what I want you to look at is the first chart that I’m showing on my screen is the federal marginal bracket where the person’s income is being taxed. So technically, they’re in a 10% tax bracket. When you hit the RMD rule here of 73, they kick up to a 15%. And then when the money gets into a larger perspective, it ends up being 25%.
My tax replication or tax simulation is assuming that in 16 months, the Tax Cuts and Jobs Act of 2017 expires and we go back to the pre-2016 tax rates. Whether that happens or not, I have no idea when I’m recording this. Right? But I want you to look at this tax return for a second. Right? So you see this 1040 on my screen, and the 1040 basically has a zero in every box except for 6A. And the combined Social Security is $73,200. The taxable amount is $2,300. After the exemption, the standard deduction of $32,000, the tax—the federal tax, total tax—is zero. Okay?
So what’s interesting is, if I put income into the plan, and I basically say, let’s look at what happens to the Social Security taxation when I pull a little bit of money out of the IRA. Here’s the whole purpose of deferring money in a retirement plan: it is to put money in at a high bracket for you and take it out at a low bracket. If I take it out of the same bracket, I didn’t make any money.
If I defer at 30% and I stay in a 30% tax bracket (I put $10,000 in the plan, it grows to $100,0000, by putting the $10,000, I deferred $3,000 in taxes. Now, it’s worth $10,000 and I’m still in a 30% bracket. It’s $3,000. Whatever rate of return it was to get to the $10,000 over that time frame, the government made the same amount of money. But if I went from the 30% bracket to the 20% bracket, now I’m making money. Okay? I’m making money. If I went from a 30% bracket to a 40% bracket, I’m not making any money. Hopefully that’s clear.
But the idea here is, if I now go in and say I’m going to take a distribution for $30,000—and why am I saying $30,000? Because that $30,000 is coming out with the standard deduction at $30,000. It’s at $32,000, right? So let’s take it out in 2024, and I put in this $30,000 withdrawal. And I go and I look at the same tax return, and what I’m seeing is that $30,000 triggered $25,000 of that Social Security to be taxed. But I’m still in an incredibly low bracket. Right?
So now I’ve got $55,000 of taxable income sheltered by $32,000 of standard deduction. I’m down to basically $2,200 of taxes because there’s $22,000—that’s that 10% bracket. So now I’m pulling $30,000 out, but the effective bracket is only 10% of the gross income. But there’s an incremental increase in the amount of taxation that is being paid.
I just want you to see this simulation. This is kind of like you’re in the laboratory trying to figure out: Should I take money, convert it to Roth? Should I take it out and spend it? Most people are going to need the money to spend, to enjoy. But the idea is, if I do $15,000 I actually triggered 12,000 to be taxable, but I still have the standard deduction. So now I don’t have any tax. So technically, that 15,000 that’s coming out of the plan is now tax-free. What do I do with it? Do I do a Roth conversion? Do I put it in a life insurance policy? Do I spend it that I need to?
But what I want you to understand is, if I take this and I just simply fast forward out to 2029, Because of the required minimum distribution, I’m at 82,000 of Social Security with 63,000 of Social Security being taxed. So that’s the triggering of the 85%. That 60 has pushed me into that bracket, and now my taxes are higher as a result of that.
Okay, so I want to go backwards for a second because I want to play the game in the laboratory, where I look at this and say 15,000 is basically—there’s no tax, right? When I take it to 55,000 right now out of it, I am triggering that Social Security, which is now 46,000 of it being taxed. So now, I’m still only effective bracket on $100,000 worth of income taxable. But it’s really 73 plus 55, right? So it’s 128,0000. It’s only $7,000. So when I look at this and say the federal bracket is 12% where money is being taxed, but my effective bracket is 7.7%.
So I think you can look at this and say there’s a chart that basically says, as I increase my income above this level, I go from not being taxed on my Social Security to being taxed at 85%. And that effective bracket becomes a greater bracket. But it’s how do I use the brackets to my advantage?
If I pull this up to the withdrawal up to 75,000—just to kind of show how the math works, right?—in this tax planning, I now have 85% of my money being taxed. I’m at 13%. I’ve got $140,000. I’m in a 10% bracket. I’m still in an extremely low tax bracket. But the visual is, as I get out into these higher levels, by deferring from the low bracket that I’m in now out to the RMD zone at 73—required minimum distribution—I’m actually getting into a 15% tax bracket. And if I look at effective, all those last dollars are being taxed on a marginal basis at 25. If—and that’s assuming tax laws sunset. If they don’t sunset, it’s going to be lower. If they sunset, we may get a new law that’s higher.
So my point of the conversation is if you’re living on Social Security, you’re probably going to be tax-free for a long time. Not 100% sure of that, but I would think that’s the case. But if you are newly retired, and you’re living just on Social Security because it’s tax-free, you’re missing a point to reposition at a lower tax bracket. And you need to do that now before you get to 73. Because once you get to 73 or 75, required minimum distributions kick in that basically say, “We don’t care what your tax bracket is. We want you to pull that money out.” Right? The more money you have, the more that’s going to do.
So, if I looked at this and said, you know, let’s assume I had money sitting somewhere else, like in a money market account or a cash account, and I don’t need to take money from the IRA—I’m going to defer this. I’m going to let this just go to, you know, make it zero that I’m pulling out of this. I don’t have any lifestyle in here so when you start to look at this, it’s an interesting thing. And I have a very low simulation as far as market returns.
But the idea is that you start to look at the net worth. At 73, the million dollars has the potential to grow to $1.3M or $1.4M. It could be more, right? But when you look at this summary, now the required minimum distribution kicks in. It’s $48,000. And by the time I’m 85, it’s $83,000. When I look at the tax payments and I’m looking at where I am, I’m in no tax from now to 72.
How much opportunity did I just miss to take money out at a lower tax bracket and deploy it in my plan to get it tax-free forever? And there’s so many different financial products that you can put the money into, that’s based upon what you have, that will help you maintain this tax-free, tax-deferred, tax-controlled, tax-advantaged way to do it. But the idea is, if you just let yourself sit here and do nothing, you’re not going to be happy with that outcome. Right? Because you always look back and go, “Oh, I wish I did this. I wish I did this.” Right?
And the purpose of Money Isn’t is to talk about how money is not one decision. Money is multiple decisions coming together in a coordinated way that are not only looking at the current, but it’s looking at the future. And the future is an unknown. But there are certain conditions that we know—such as tax law sunsetting—but we don’t know if it actually happens the way we think it’s going to happen. But if I’m planning, there are things that I can do before the year end. I can get money into places that I’m not even going to pay tax. And from that, we already know if I put in that 15,000, there’s no tax. But what’s the point where that is almost nothing?
Let’s say I take out $30,000 from that account and I reposition it into a Roth. Let’s just use that as an example for a second. That $30,000 was just $10,000—it’s $2,200 of taxes. I probably deferred it at 30. Now I take it and put it into something completely out of the tax future, assuming that the laws don’t change, right? But is it worth that in my plan to pay a little bit of tax to move it into something that’s never going to be taxed? Or should I just let it sit and then get destroyed with taxes in the future? You can answer that question on your own.
And the reason why I wanted to bring this up is that if somebody that’s doing this right and they’re not looking at the longer term of their plan and the pressures that they’re going to have with increased taxes and inflation and planned obsolescence and technological change, and they’re looking at this and saying, you know, here is—this is a really interesting spot, right?
We’re looking at the screen, and the screen is basically saying 24 and 25 is the current tax law. 26, the tax law changes, and it sunsets back to the old 2016 tax law. And everybody believes that when the SALT deduction gets restored and everything comes back in, that we’re going to be paying less taxes. So this person’s income—because of inflation that it had on it—goes from 59,000 to 64,000. So it’s basically a $5,000 increase. The total tax goes from 2,600 to 3,440. It’s like $900. It’s like 15–18% of additional tax on that additional money. Like the tax rate becomes higher and higher and higher.
But if I scroll down the chart, all of a sudden I get into the RMD world, and my income goes from 74,000 to 153,000. My tax is now 18,000. And that is a projection based upon what we currently know. That’s dangerous, because I don’t know that. But I know what I did miss is the opportunity in this low-tax environment, where I was paying little or no taxes, to reposition this money in a location that will benefit me or give me what I’m going to call tax flexibility in the future—meaning control.
If I have money in an IRA and I need money, the only place to get the money is out of the IRA and I got to pay tax. Or I can reposition it into a tax-deferred or tax-free environment such as a Roth or into a cash value life insurance policy or a non-qualified annuity that I can get money out through.
And I can do the same investments inside a Roth and outside of a Roth. So it’s not necessarily any one particular strategy, but the idea is that I want to make sure that I’m not compounding and paying more and more taxes. Because there’s a point where I can’t do Roth conversions, because I can’t do a Roth conversion on a required minimum distribution.
My takeaway is, if this is in your plan, And you’re looking at this and saying, “I’m not going to pay any taxes, but I’m not looking downstream”, I want you to do that. I want you to get together with somebody that can help you make good decisions today to help you move money from future tax to no tax.
That’s the goal. Thank you for listening. Share it, like us, give feedback!
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