Wednesday, August 10, 2022

Are Social Security Benefits Taxed

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State Taxes Are Different

Good Question: Why Are Social Security Benefits Taxed?

Just over half of states, in addition to Washington D.C., either do not collect income tax or do not factor Social Security income into those tax considerations. The remaining 24 states may tax Social Security income, but they don’t all handle taxes the same way. Some of these states will tax up to the same 85% of benefits as the federal government. Others tax Social Security benefits to some extent but they offer breaks based on your age and income level.

Don’t neglect to plan for state taxes. Consider touching base with a tax professional to determine what, if any, tax breaks you might qualify for locally.

Converting Savings Into A Roth Ira

“One strategy to reduce the taxes you pay on your Social Security income involves converting traditional 401 or IRA savings into a Roth IRA,” says Shailendra Kumar, director at Fidelity’s Financial Solutions.

Not everyone can contribute to a Roth IRA or Roth 401 because of IRS-imposed income limits, but you still may be able to benefit from a Roth IRA’s tax-free growth potential and tax-free withdrawals by converting existing money from a traditional IRA or a workplace retirement savings account into a Roth IRA. This process of converting some of your IRA or 401 into a Roth IRA is known as a partial Roth conversion.

“You can choose to convert as much or as little as you want of your eligible traditional IRAs. This flexibility enables you to manage the tax cost of your conversion,” adds Kumar. “A Roth IRA or Roth 401 can help you save on taxes in retirement. Not only are withdrawals potentially tax-free,2 they won’t impact the taxation of your Social Security benefit. This is an important aspect of a Roth account that most people are not aware of.

Remember: The amount you convert is generally considered taxable income, so you may want to consider converting only the amount that could bring you to the top of your current federal income tax bracket. You also may want to consider basing your conversion amount on the tax liability you may incur, so you can pay your taxes with cash from a nonretirement account. Consult a tax professional for help.

Change In How You Report Earnings

The Social Security Administration bases its benefit calculations on earnings reported on W-2 forms and on self-employment tax payments. Most individuals are not required to send in an estimate of earnings.

However, the Social Security Administration does request earnings estimates from some recipients: those with substantial self-employment income or those whose reported earnings have varied widely from month to month, including people who work on commission. Toward the end of each year, Social Security sends those people a form asking for an earnings estimate for the following year. The agency uses the information to calculate benefits for the first months of the following year. It will then adjust the amounts, if necessary, after it receives actual W-2 or self-employment tax information in the current year.

Once a beneficiary reaches full retirement age, his or her income will no longer be checked. Because there is no Social Security limit on how much a person can earn after reaching full retirement age, there is nothing to report.

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Withdraw Taxable Income Before Retirement

Another way to minimize your taxable income when drawing Social Security is to maximize, or at least increase, your taxable income in the years before you begin to receive benefits.

You could be in your peak earning years between ages 59½ and retirement. Take a chunk of money out of your retirement account and pay the taxes on it. You can use it later on without pushing up your taxable income.

For example, you could withdraw funds a little earlyor “take distributions,” in tax jargonfrom your tax-sheltered retirement accounts such as IRAs and 401s. You can make distributions penalty-free after age 59½. That means you avoid being dinged for making these withdrawals too early, but you must still pay income tax on the amount you withdraw.

Since the withdrawals are taxable , they must be planned carefully with an eye on the other taxes you will pay that year. The goal is to pay less in tax by making more withdrawals during this pre-Social Security period than you would after you begin to draw benefits. That requires considering the total tax bite from withdrawals, Social Security benefits, and any other sources.

Be mindful, too, that at age 72, you’re required to take minimum distributions from these accounts, so you need to plan for those mandatory withdrawals.

If You Work More Than One Job

56% of Social Security Households Pay Tax on Their ...

Keep the;wage base in mind if you work for more than one employer. If you’ve earned $69,000 from one job and $69,000 from the other, you’ve crossed over the wage base threshold. Neither employer should withhold any further Social Security tax from your payor pay half the 12.4% on your behalfuntil year’s end.

It doesn’t matter that individually, neither job has reached the wage base threshold. The wage base threshold applies to all your earned income. But separate employers might not be aware you’ve collectively reached this limit, so you’ll have to notify both employers they should stop withholding for the time being. However, you can always receive reimbursement of any overpayment when you file your taxes.

These are annual figures, so the Social Security tax starts right back up again on Jan. 1 until you hit the next year’s Social Security wage base.;

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How The West Taxes Social Security

Nine of the 13 states in the West don’t have income taxes on Social Security. Alaska, Nevada, Washington, and Wyoming don’t have state income taxes at all, and Arizona, California, Hawaii, Idaho, and Oregon have special provisions exempting Social Security benefits from state taxation. That leaves Colorado, Montana, New Mexico, and Utah, which impose taxes on Social Security for some individuals.

What Is Social Security Tax

It is a tax charged on the employer and the employee to fund the social security program. It is collected in the form of self-employment tax or payroll tax. Employers usually withhold the tax from the employees paycheck and remit it to the relevant government authority. This amount is used to pay retirees and people who have various disabilities. Social security tax is also used to support people who are entitled to survivorship benefits.

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Income Taxes And Your Social Security Benefit

Some of you have to pay federal income taxes on your Social Security benefits. This usually happens only if you have other substantial income in addition to your benefits .

You will pay tax on only 85 percent of your Social Security benefits, based on Internal Revenue Service rules. If you:

  • file a federal tax return as an “individual” and your combined income* is
  • between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your benefits.
  • more than $34,000, up to 85 percent of your benefits may be taxable.
  • file a joint return, and you and your spouse have a combined income* that is
  • between $32,000 and $44,000, you may have to pay income tax on up to 50 percent of your benefits.
  • more than $44,000, up to 85 percent of your benefits may be taxable.
  • are married and file a separate tax return, you probably will pay taxes on your benefits.
  • How Much Of Your Social Security Is Taxable

    How to pay less in taxes on your Social Security benefits

    Its possible and perfectly legal to avoid paying taxes on your Social Security check. In fact, only about 40 percent of recipients pay any federal tax on their benefit.

    But heres the caveat: To receive tax-free Social Security, your annual combined, or provisional, income must be under certain thresholds:

    • $25,000, if youre filing as an individual
    • $32,000, if youre married filing jointly

    For married filing separately, the Social Security Administration simply says that youll probably pay taxes on your benefits.

    Your combined income consists of three parts:

    • Your adjusted gross income, not including Social Security income
    • Tax-exempt interest
    • 50 percent of your Social Security income

    Add those amounts up and if youre under the threshold for your filing status, you wont be paying federal taxes on your benefit.

    Even if youre above this threshold, however, you may not have to pay tax on your full benefit. You may pay taxes on only 50 percent of your benefit or on up to 85 percent of it, depending on your combined income.

    • For individual filers:
    • Combined income between $25,000 and $34,000, up to 50 percent of your benefit is taxable
    • Combined income above $34,000, up to 85 percent of your benefit is taxable
  • For married filing jointly:
  • Combined income between $32,000 and $44,000, up to 50 percent of your benefit is taxable
  • Combined income above $44,000, up to 85 percent of your benefit is taxable
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    State Taxation Of Social Security Benefits

    In addition to federal taxes, some states tax Social Security benefits, too. The methods and extent to which states tax benefits vary. For example, New Mexico treats Social Security benefits the same way as the federal government. On the other hand, some states tax Social Security benefits only if income exceeds a specified threshold amount. Nebraska, for instance, taxes Social Security benefits only if your income is at least $43,000, or $58,000 if you’re married filing a joint return. Utah includes Social Security benefits in taxable income but allows a tax credit for a portion of the benefits subject to tax.

    Waiting Until Later Is Ideal But Life Can Get In The Way

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    Its best to wait until youre 70 to start taking Social Security retirement benefits even if it means tapping into your retirement assets at the bottom of a bear market. Why? Because the guaranteed, risk-free 8% annual Social Security benefit increase is an unbeatable deal.

    And yet in 2018 only 6% of women and 4% of men waited until they turned 70 to claim benefits. Most advisers and financial columnists wag their fingers at people who take Social Security as soon as they qualify at age 62. Yet some 31% of women and 27% of men tapped into Social Security at that age in 2018. Its hard to say no when somebody is offering you a pot of money right now.

    There are some bad reasons to do this, such as because all your friends are doing it or because youd better grab the benefits before Social Security runs out of money. I suspect that before that happened, Congress would raise payroll taxes for high-income people rather than cut benefits for one of the nations largest, most active voting blocs.

    But there are some decent reasons to start taking benefits early, and the recession in the wake of the COVID19 pandemic has dramatically highlighted one of them: many people dont have much choice. Well get into that later.

    Sometimes you just gotta do what you gotta do.

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    The Impact Of Roth Iras

    If youre concerned about your income tax burden in retirement, consider saving in a Roth IRA. With a Roth IRA, you save after-tax dollars. Because you pay taxes on the money before contributing it to your Roth IRA, you will not pay any taxes when you withdraw your contributions. You also do not have to withdraw the funds on any specific schedule after you retire. This differs from traditional IRAs and 401 plans, which require you to begin withdrawing money once you reach 72 years old, or 70.5 if you were born before July 1, 1949.

    So, when you calculate your combined income for Social Security tax purposes, your withdrawals from a Roth IRA wont count as part of that income. That could make a Roth IRA a great way to increase your retirement income without increasing your taxes in retirement.

    Another thing to note is that many retirement plans allow individuals, aged 50 years or older, to make annual catch-up contributions. For 2021, you can make catch-up contributions up to $1,000. These must be made by the due date of your tax return. You have until April 15, 2022 to make the $1,000 catch-up contribution apply to your 2021 Roth IRA contribution total.

    At What Age Is Social Security No Longer Taxed

    Working in retirement

    At 65 to 67, depending on the year of your birth, you are at full retirement age and can get full Social Security retirement benefits tax-free. However, if youre still working, part of your benefits might be subject to taxation. The IRS adds the figures for your earnings and half your Social Security benefits.

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    Youre Single And Have Health Issues

    If youre single and have health issues, you may just want to use a simple break-even analysis. This calculation compares what youll receive in cumulative lifetime benefits for filing at various ages. ;

    For example, if youre trying to compare filing at 62 versus what youd receive if you filed at 67, a break-even analysis would tell you that you need to live longer than age 78 for filing at 67 to make more sense over filing at age 62.

    You can run all sorts of age combinations in these calculations, but if youre single and have health issues, this is probably where filing early makes the most sense because youre not worried about increasing survivor benefits or the host of other factors that married individuals have to worry about.

    For more information on this specific topic, check out this great article on the break even analysis at dummies.com.

    Know The Earnings Limits

    Those hoping to work in retirement need to be especially careful if they’re planning to claim Social Security benefits early. Even if youâre just working part-time, itâs important to consider how that continuing income will affect your benefits.

    The SSA caps how much you are allowed to earn if you start taking your benefits before full retirement age, which is 66 for most baby boomers. In 2021, the annual earned income cap is $18,960, and for every $2 you earn over that limit, the SSA withholds $1 off the top of your benefits. So if you earn $20,960 this year and you haven’t yet reached the year you will turn full retirement age, your benefits will be reduced by $1,000âon top of any income taxes you may have to pay on the remaining benefits. Once you reach the year that you’ll turn full retirement age, the earned income cap goes up to $50,520 and for every $3 you go over, it’s a $1 withholding.

    There is some good news, however: Because the penalty is determined by your individual earned income, if you retire early but your spouse doesn’t, your spouse’s earned income will not be factored into the earnings limit. Additionally, when you reach your full retirement age, the earnings limit disappears and Social Security will recalculate your benefit amount if you were negatively impacted by the earnings limit.

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    Are Spousal Survivor Disability And Ssi Benefits Taxable

    These programs all follow the same general rules as the Social Security program for retirees, with one exception: Supplemental Security Income, or SSI for short, is not a Social Security program. It’s a separate program for people who are needy and disabled people, and payments from it are not taxable.

    Other Things To Watch Out For

    Are Social Security Benefits Taxable?

    While everyone likes to minimize their taxes, especially ones that you can avoid without too much legwork, its important that you keep things in perspective.

    Tax strategy should be part of your overall financial planning, says Crane. Dont let tax strategy be the tail that wags the dog.

    In other words, make the financial moves that maximize your after-tax income, but dont make minimizing taxes your only goal. After all, those who earn no income also pay no taxes but earning no income is not a sensible financial path. For example, it can be better to find ways to maximize your Social Security benefits rather than minimizing your taxes.

    And it could be financially smart to first avoid some of the biggest Social Security blunders.

    Dont forget that these rules apply to minimizing your tax at the federal level, but your state may tax your Social Security benefit. The laws differ by state, so its important to investigate how your state treats Social Security.

    There really arent any tricks, you just have to be careful with your interest and dividends, says Paul Miller, CPA, of Miller & Company in the New York City area.

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    If Social Security Is Your Only Income

    You almost certainly won’t have to pay income tax on your Social Security benefits if they are your only source of income. That means your Social Security income probably isn’t taxable if you never got around to investing in a 401, if you don’t rent out a property for profit, or if you’ve given up working entirely. These are just examplesthe point is that you have no other form of income from any source.

    You might not even have to file a tax return in this situation, but check with a tax professional before you forgo filing altogether.

    States That Don’t Tax Social Security Benefits

    Many people are surprised to learn that they can end up having to pay federal income tax on their Social Security benefits. To add insult to injury, some states also require residents above a certain income threshold to pay state income tax on what they receive from Social Security. Yet the majority of states are kind enough;not;to tax Social Security, so it’s worth considering the issue in choosing where you want to live after you quit your job and start drawing your benefits.

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