Question: I am 62, married and plan to retire in June. I know that I can start collecting 80 percent of my Social Security benefits this year, but I'll also be taxed on those benefits. Should I hold off collecting benefits until I reach 65 or later to avoid the tax? Or should I start taking benefits now because of the new Social Security proposals? (I'm in the 28 percent tax bracket.) – J.H., Columbus, Ohio
Answer: Millions of early retirees ask the same question ever year: "Should I receive 80 percent of Social Security benefits at 62 or wait until 65 to receive 100 percent of benefits?" But this decision has less to do with the taxation of the benefits than it does with your anticipated cash flow in retirement.
A portion of your Social Security benefits is taxable if your "provisional income" exceeds a base amount. Provisional income is defined as your modified adjusted gross income (AGI) plus one-half of the Social Security benefits received. The initial base provisional income amount is $32,000 for joint filers. If your provisional income exceeds a second threshold—$44,000 for joint filers—as much as 85 percent of the benefits received may be taxable. Putting aside this year (when you still have work-related income), your provisional income is likely to be lower in your retirement years.
You may be able to reduce the tax bite on benefits in the future by lowering your provisional income through tax-smart investing. For example, you can reduce your provisional income if you switch investments in dividend-paying stock to growth stock that doesn't pay current income. Note: Tax-free municipal bond income counts as provisional income for this purpose.
Social Security reform proposals are still taking shape on Capitol Hill, and Congress doesn't appear likely to vote on the issue this year. But either way, most proposals (including President Bush's) acknowledge that benefits for current retirees wouldn't be affected.