My wife and I hosted Thanksgiving dinner for my siblings last week. We are all now in our 60s and have reached that point in our lives when we have only ourselves to take care of.

For that reason, it wasn’t long until the subject of retirement came up. One of my sisters asked, “A friend told me that my Social Security benefit will be taxed at the 85% rate. Is that true?”

I hear that question a lot, which troubles me since it is so far from the truth. What is true is that up to 85% of your Social Security could be subject to income taxation.

The extent to which your Social Security benefit is taxable is based on your “combined income.” Combined income consists of your adjusted gross income plus nontaxable interest income (i.e., municipal bonds) plus half of your Social Security benefit.

If that amount exceeds $34,000 for a single filer or $44,000 for a joint filer, then 85% of your Social Security benefit is taxable at your effective rate. Only 50% of your benefit is taxable for combined income from $25,000 to $34,000 for single filers and from $32,000 to $44,000 for joint filers.

For combined income below those thresholds, none of your Social Security benefit is subject to taxation. And even for combined income far in excess of the upper limits, your Social Security benefit is never entirely subject to income taxation.

Pay Me Now or Pay Me Later

With that misunderstanding out of the way, we moved on to another source of anxiety regarding Social Security. “I’d like to retire now at age 64,” one of my sisters commented,” but if I start taking my Social Security benefit now I’ll get less money.”

In terms of the amount of the monthly benefit, that statement is absolutely true. She was born in 1957, so the full retirement age (FRA) for her Social Security benefit is 66 and 6 months.

Since my sister is within three years of her FRA, the size of her monthly payment would be reduced by 5/9 of one percent for each month prior to reaching that age. If she starts getting it now when she is two years shy of her FRA, her monthly benefit would be reduced by approximately 13% of her full benefit for the rest of her life.

Of course, starting her Social Security benefit now also means that she will receive more monthly payments over the course of her lifetime. Assuming her future Social Security benefits increase by an average annual COLA (cost of living adjustment) of 3%, it would take 218 months, or about 18 years, for her to collect more money by waiting until her FRA to start collecting her Social Security benefit.

In 18 years she will be 82 years old, which by no coincidence syncs up with her remaining life expectancy. As far as the Social Security Administration is concerned, it all works out the same for the population as a whole so it makes no difference to them when you start receiving your monthly benefit.

How Lucky Do You Feel?

When I have this conversation with women, they almost always opt for waiting until their FRA to start receiving benefits. They believe they will live beyond their expected mortality and want more income later in life when they may be widowed and on their own.

However, when I have the same conversation with men, they usually go the other way. “I know I can enjoy that money now,” most of them say, “but I don’t know if I’ll still be around in another 20 years to get any use out of it.”

Earlier in my career when I was a financial planner, I felt it was not my place to tell my clients which choice to make. That’s because it is a value judgment based on personal circumstances that only they can make for themselves.

But what I could do is make sure they correctly understood the choice they were being asked to make. In this case, my sister was relieved to know that she would pay considerably less income tax on her Social Security benefit than she thought.

As for when my sister will start receiving her benefit, for now she is going to wait. But it’s comforting for her to know that it’s there whenever she really needs it.

Of course, all of that assumes that the rules regarding Social Security taxation do not change in the future. I wouldn’t bet on that, especially now that the federal deficit has ballooned as a result of the coronavirus pandemic.

That’s why I advocate creating your own income stream in retirement entirely separate from your Social Security benefit. And for that, you need look no further than my colleague, Jim Fink.

As chief investment strategist of Velocity Trader, Jim Fink has devised methodologies that reap big profits, regardless of the ups and downs that bedevil conventional investors.

Jim has put together a new presentation that shows smart investors how to make massive investment gains in a short amount of time. Click here now for access.