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Investing Blog Roundup: Getting an Accurate Benefit Estimate from Your Social Security Statement

The benefit estimate on your Social Security statement assumes that you retire and file for retirement benefits on the same date — and the SSA’s online calculators make the same assumption. So how can you calculate a benefit estimate if you plan to retire prior to (or after) filing for benefits?

Short answer: by using either of two calculators from the SSA and a very slight bit of arithmetic.

Other Recommended Reading

Thanks for reading!

Repaying the Advance Premium Tax Credit (Form 8962) as a Dependent

A reader writes in, asking:

“I have a question regarding Form 8962 (Premium Tax Credit). I am a dependent, received Advance Premium Tax Credit, and have to file 8962 since nobody will actually be claiming me as a dependent. Last year it was simple because publication 974 provided clear instructions for my situation. There was a section that provided instructions for people claiming no personal exemptions, as would be the case for somebody who is a dependent.

This year those instructions are absent since nobody can claim personal exemptions. I’m confused about how to proceed, especially regarding lines 1-5.”

Firstly just to make sure we’re clear on this point: people still can claim dependents, even though the exemption amount is currently set to zero. (Dependents might be claimed for the child tax credit, American Opportunity Credit, or for other assorted purposes.)

If you are claimed as somebody’s dependent, then you are not eligible for the premium tax credit, and you do not file Form 8962. Rather, it is the person who claims you as a dependent who would file Form 8962 for the purpose of calculating any premium tax credit and, if necessary, repaying any excess advance premium tax credit.

If you are confident that nobody is claiming you as a dependent for the year, but you could be claimed as somebody’s dependent for the year, then you would fill out Form 8962 to indicate that you were not eligible for the premium tax credit (because you can be claimed as somebody’s dependent). That is, you would enter zero as your family size (assuming you are not married). And the household income (i.e., MAGI of the people in the household) is zero, because the family size in question is zero. And because the premium tax credit is not allowed to anybody who could be claimed as a dependent, the premium tax credit (line 24) is zero. And then lines 27, and 29 would ultimately reflect the fact that any advance premium tax credit is excess advance premium tax credit.

Now, those are the rules, and that is how I would personally fill out the return in such a situation. But I’m sure I will receive several emails pointing out the following if I do not mention it: some people would encourage you to not check the “I can be claimed as somebody’s dependent” box if nobody else is actually claiming you as a dependent — because if nobody claims you as a dependent, it would be hard for the IRS to be aware of the fact that somebody could claim you as a dependent. And if you are not somebody else’s dependent, then you could be eligible for the premium tax credit.

But again, the Code sections in question (36B, 151, 152) are very clear on this point: if you could be claimed as a dependent, you are not eligible for the premium tax credit. And I would suggest filing accordingly.

For More Information, See My Related Book:


Taxes Made Simple: Income Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • The difference between deductions and credits,
  • Itemized deductions vs. the standard deduction,
  • Several money-saving deductions and credits and how to make sure you qualify for them,
  • Click here to see the full list.

A testimonial from a reader on Amazon:

"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!"

Investing Blog Roundup: Financial Advisory Costs Falling

Schwab announced yesterday that they will be switching to a flat, low-cost price for financial planning services via their “Schwab Intelligent Portfolios Premium” program. For a cost of $30 per month, plus a one-time $300 initiation fee, the client will receive a “comprehensive financial plan” and “unlimited one-to-one guidance” from a CFP.

Other Recommended Reading

Thanks for reading!

Solo 401(k) Contributions and Qualified Business Income Deduction (Pass-Through Deduction)

A reader writes in, asking:

“What is the relationship between the new ‘pass-thru’ income deduction for ‘qualified business income’ and the contribution limits for self-employed retirement plans such as a Solo 401-K?”

Firstly, the new deduction does not have any effect on how much you can contribute to a solo 401(k) — or to a SEP or SIMPLE.

Contributions to such accounts do, however, affect the amount of your qualified business income (QBI) deduction. That is, the deduction you get from pre-tax contributions to such accounts reduces your qualified business income, which reduce your deduction for such income.

Why Do Pre-tax Contributions Reduce Qualified Business Income?

Given that deductions for a self-employed person’s own contributions to a SEP IRA, SIMPLE IRA, or solo 401(k) do not appear on Schedule C (i.e., they do not reduce self-employment income) it surprises many people that such contributions are considered to reduce qualified business income. Nonetheless, they do.

According to the instructions to Form 1040, qualified business income is reduced by “other deductions attributable to the trade or business including, but not limited to, deductible tax on self-employment income, self-employed health insurance, and contributions to qualified retirement plans.”

The Regulations on the topic say essentially the same thing: “In general, deductions attributable to a trade or business are taken into account for purposes of computing QBI to the extent that the requirements of section
199A and §1.199A-3 are otherwise satisfied. Thus, for purposes of section 199A, deductions such as the deductible portion of the tax on self-employment income under section 164(f), the self-employed health insurance deduction under section 162(l), and the deduction for contributions to qualified retirement plans under section 404 are considered attributable to a trade or business to the extent that the individual’s gross income from the trade or business is taken into account in calculating the allowable deduction, on a proportionate basis.”

Those two references only mention contributions to qualified plans (i.e., 401(k) plans, rather than SEP/SIMPLE IRA accounts) explicitly, but it’s clear that the same line of reasoning would apply to SEP IRA or SIMPLE IRA contributions. (Also, for what it’s worth, TurboTax clearly takes that position in its tax calculations.)

Financial Planning Implications

Essentially, your marginal tax rate for qualified business income is lower than it would be without the deduction (because each additional dollar of income causes you to get $0.20 of deduction, subject to phaseouts). In other words, pre-tax SEP/SIMPLE/solo 401(k) contributions aren’t as valuable as they would be without accounting for the QBI deduction.

As a result, Roth contributions would now make sense in some cases where tax-deferred contributions would have made sense before.

Also, if your household is doing some tax-deferred contributions and some Roth contributions, it will be advantageous to make sure that, to the extent possible, your tax-deferred contributions are to accounts that will not reduce your qualified business income. For example if you are self-employed and your spouse has a “regular” job as an employee, it would be preferable for your spouse to make tax-deferred 401(k) contributions while you make Roth solo 401(k) contributions rather than vice versa or doing 50/50 each.

Example: You’re in the 22% tax bracket. A $10,000 pre-tax contribution to your spouse’s 401(k) saves you $2,200 (ignoring state/local income taxes for simplicity’s sake). Conversely, a $10,000 pre-tax contribution to your solo 401(k) only saves you $1,760. That is, at first glance it saves you $2,200, but it also reduces your QBI by $10,000 and therefore reduces the size of your QBI deduction by $2,000 (i.e., 20% of $10,000), which causes an additional $440 of income tax (i.e., 22% of $2,000).

If your business is a specified service business and your taxable income is in the phaseout range, the key message is the same: your marginal tax rate for your qualified business income will be something other than simply your tax bracket. So it will be important to actually do the math before making any related decisions.

For More Information, See My Related Book:

Independent Contractor, Sole Proprietor, and LLC Taxes Explained in 100 Pages or Less

Topics Covered in the Book:
  • Estimated tax payments: When and how to pay them, as well as an easy way to calculate each payment,
  • Self-employment tax: What it is, why it exists, and how to calculate it,
  • Business retirement plans: What the different types are, and which one is best for you,
  • Click here to see the full list.
A testimonial from a reader on Amazon:
"Quick and easy read. No fluff, just straight to the point and gives you more helpful information that you might imagine. If you are looking to get the bottom line information you need to start your business right then this book is a must have."

Investing Blog Roundup: Selecting a (Next?) Career

I know that many readers are currently in the process of planning a next career (in many cases, as part of a phased retirement process). There’s no shortage of advice on career selection, but this week I encountered a brief article that actually has some evidence-based advice on the matter.

Relatedly, if you are currently trying to improve the satisfaction/fulfillment you derive from your existing line of work, you may enjoy Cal Newport’s book Deep Work.

Other Recommended Reading

Thanks for reading!

Social Security with Foreign Work History: Totalization Agreements

Last week I was a guest on Rick Ferri’s Bogleheads on Investing podcast. You can listen to that podcast here. (The Bogleheads discussion thread is here, if you want to post any comments.)

One question that a few Bogleheads had asked was about how a US citizen can qualify for U.S. Social Security benefits if they were covered under a foreign social security system for a portion of their working career.

I gave a very brief answer on the podcast, but I wanted to discuss that topic more thoroughly here.

In short, how exactly it plays out depends on which other country you worked in. The U.S. has “totalization agreements” with many countries that provide the rules for how a worker will be treated, but the exact details vary from one agreement to another. (There’s no way around such a situation, given that each country has its own unique tax and social security systems.)

And, unfortunately, given that the specifics vary for each of the agreements, it’s unlikely that you’ll find anybody who is a true expert on any one of them. (I most definitely am not. Despite dealing with Social Security topics all the time, it would be rare for me to get even two people asking about the same totalization agreement in a given year.)

Generally speaking, however, the effects of the totalization agreements are to:

  1. Eliminate dual taxation that would otherwise occur (i.e., simultaneously paying into two countries’ social security systems), and
  2. Allow you to qualify for benefits when you might not otherwise qualify.

Qualifying for Benefits (“Totalization”)

If you meet all the basic requirements under one country’s system, you will get a regular benefit from that country.

If you have at least 6 credits (“quarters of coverage”) under the U.S. Social Security system, but you do not have the 40 credits that would ordinarily be necessary to qualify for a retirement benefit, your credits will be “totalized.” That is, your credits under the foreign social security system will be counted toward qualifying for U.S. Social Security.

And the opposite would happen as well — if you don’t quite qualify for coverage under the foreign social security system, totalization would allow your U.S. periods of coverage to be counted toward qualifying there.

Calculating Benefits

If you end up qualifying for U.S. Social Security benefits via totalization, there is a special set of rules for calculating the benefit. You can find the exact details here, but very roughly what’s going on is that:

  • Only your U.S. earnings are included in the calculation, and
  • The benefit that is calculated based on those U.S. earnings is ultimately multiplied by a fraction, which represents the portion of your career for which you were paying into the U.S. system.

Windfall Elimination Provision and Government Pension Offset

Usually, when you receive a pension from employment for which you did not pay U.S. Social Security taxes, the windfall elimination provision (WEP) applies, reducing your primary insurance amount. With regard to foreign social security benefits, however, the WEP will not apply if you are:

  • Entitled to a U.S. totalization benefit (i.e. you only qualified for a U.S. Social Security benefit by counting your credits from the foreign social security system), or
  • Entitled to a regular U.S. benefit, as well as a foreign benefit which is based on a totalization agreement with the U.S. (i.e. you only qualified for the foreign social security benefit via counting your U.S. credits), and you are not receiving any other pension based on non-covered work (e.g., a pension from the state of Illinois).

Finally, a foreign social security benefit will not trigger the government pension offset (GPO).

Want to Learn More about Social Security? Pick Up a Copy of My Book:

Social Security cover Social Security Made Simple: Social Security Retirement Benefits and Related Planning Topics Explained in 100 Pages or Less
Topics Covered in the Book:
  • How retirement benefits, spousal benefits, and widow(er) benefits are calculated,
  • How to decide the best age to claim your benefit,
  • How Social Security benefits are taxed and how that affects tax planning,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"An excellent review of various facts and decision-making components associated with the Social Security benefits. The book provides a lot of very useful information within small space."
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