The importance of non-reportable income to Middle AmericaArticle added by Jeff Reed on August 16, 2013
Jeff Reed

Jeff Reed

San Diego, CA

Joined: May 07, 2012

The reality is that high income earners are not the only ones affected by means testing and the recent changes in tax laws under Obamacare.

In fact, when you start to look at means testing and the income levels at which Social Security and Medicare benefits are impacted, these changes may be more meaningful for Middle America than for those with high net worth. We've already explored the tax increases that the wealthy face in 2013, and when you add in the phase-out of many deductions based on PEP and Pease, it's clear that the wealthy are taking a big hit.

But when we look at the magnitude of the change in real dollars, like the loss of the $3,900 personal exemption over $372,000 in income, are the high-income earners really going to care?

I think they care much more about the tax rate increases. These other items, while still worth mentioning, are but another layer on a cake they already don't want to eat.

When our focus changes to those who are going to have a more marginal retirement, some aspects of means testing become much more significant. Taxation of Social Security benefits, for instance, begins at income levels as low as $44,000. Similarly, Medicare costs begin to increase at an $85,000 income.

The impact on Social Security

To gain a deeper level of understanding on the issue, let's talk real dollars, starting with Social Security.

If Middle American clients are maximizing their Social Security benefits, they can bring in roughly $30,000 per year. If they also have income from other sources, and their income totals $100,000, they're going to pay tax on a portion of their Social Security income. Sure, tax is taking a smaller bite out of their income than that of a wealthy, high-income client, but look at the significance of those dollars. To the high-income client, taxing their benefits is a nuisance. For the average client, however, paying an additional $10,000 in tax can become a big problem.

The impact on Medicare

Medicare costs are much the same.

Rather than benefits being subject to tax, Medicare costs rise if an individual has "too much" income. Sounds ominous, and no one is excited about paying more. However, when we look at the increase in real dollars, it totals $3,900 per year.

Again, not an insignificant amount of money, but much more meaningful to the average Joe than the high-net-worth client.
Life insurance as a source of income

Taken together, these two issues can spell trouble for a retirement plan. The tax benefits of using life insurance as a source of income in retirement are already well known and become increasingly important in a period of rising tax rates.

The other feature of income from a life contract — the fact that it's non-reportable — may make life insurance a critical component of an effective retirement plan in the new economy. Tax efficient income that preserves benefits from social welfare programs could make the difference between a client's comfortable retirement and a client outliving his money.

For the average client mentioned above, saving him even half of the taxes paid on his Social Security benefits and reducing his Medicare costs could increase his net income by $7,000. I'm certain that the 7 percent increase will be very meaningful to him.
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