The recent tough economy has given rise to the number of people who seriously consider drawing on their Social Security benefits early.  Lack of employment opportunities and a steady increase in the cost-of-living makes taking Social Security at age 62 an attractive option.  The simple fact, however, is that people who choose to collect benefits early often unwittingly penalize themselves later on in life.

Taxpayers who earn wages or self-employment income while also collecting Social Security benefits risk having those benefits reduced based on two factors: Age and Income.  Here’s the real shocker… Taxpayers only realize that their Social Security benefits are reduced at the time they’re filing their year-end taxes.  So when taxpayers file a tax return showing that they received both wages and Social Security benefits, calculations kick in that determine whether a taxpayer should return some of the money that they received earlier.

The act of “returning” Social Security benefits actually occurs at the time a year-end tax return is filed and is realized when a taxpayer views their tax return and is shocked to learn that their expected refund is drastically reduced or that they actually owe a large amount on their taxes.

As mentioned earlier, the amount of money a taxpayer is allowed to earn while also receiving Social Security benefits depends on Age and Income Amount.  For people who collect Social Security benefits before they reach Full Retirement Age the income threshold before a taxpayer’s Social Security benefits are reduced is $15,120.  For every $2 a taxpayer in this category earns after $15,120, $1 of Social Security benefits must be forfeited.

Simplified example: If Bob, age 63, starts drawing SS benefits while earning $25,120 at his job, he will forfeit 50% of the income earned above the $15,120 exempt earnings.  That’s half of $10,000 (or $5,000) that’s forfeited! Plus he will no doubt have to pay some taxes on the $10,000.

Another major consideration is how earnings might impact one’s taxable income when also collecting social security benefits. In fact up to 85% of one’s benefits could be added to other income in ultimately arriving at a taxable income figure. A single filer will have a portion of the SS benefits added when other income equals $25,000 while this occurs at $32,000 for married filing joint filers. The amount added is based on a scale established by the IRS – maxing out at 85%. This addition has, on more than one occasion, elevated taxpayers into the next tax bracket.

The bottom-line is this… earning wage or self-employment income while simultaneously drawing Social Security benefits can have a significant impact on your tax return.  This can be especially problematic if a taxpayer starts taking Social Security benefits before reaching Full Retirement Age.  If you’re not familiar with the complications that can arise it’s probably a good idea to meet with the tax professionals at Cloister Tax Services.  We can evaluate your situation and help you plan accordingly.