Tuesday, September 27, 2022

Do You Pay Social Security Tax After Retirement

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How Benefits Are Calculated

How is Your Social Security Benefit Taxed in Retirement?

Social Security benefits are calculated based on your 35 highest-earning working years. Therefore, if you keep working and earn a higher salary in your 60s than you did earlier in your career, you could boost your Social Security payments even more.

If you don’t really need the money as soon as you reach full retirement age and are in good health, it’s probably wise to wait until you turn 70 to apply. “When you think of Social Security the right way, as insurance against outliving your money, then it makes sense to wait until age 70 for the highest payout available,” says Robert R. Schulz, CFP®, president of Schulz Wealth in Mansfield, TX.

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    How To Minimize Federal Taxes In Retirement With A Pension

    You can minimize federal taxes in retirement on your FERS pension by contributing as much money to Roth accounts as possible. Unfortunately, you cannot do much more than that.

    So- should you contribute to your Roth TSP? I compared the Roth and Traditional TSP in an earlier post. I believe that for most people it is a toss-up.

    However, I want you to know that Brian and I disagree about the importance of Roth contributions. So I thought I should lay out both of our arguments so you can make your own decision.

    Recommended Reading: What Is The Best Month To Start Social Security

    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.

    Smart Idea: Use Tax Arbitrage To Your Advantage

    Pay Less Retirement Taxes

    Up to 85% of your Social Security benefits received can be taxed. After taxes, a dollar of Social Security income is worth more than a dollar of IRA withdrawals.

    If you design a retirement income plan that takes advantage of this tax arbitrage, it can make a big difference over the course of your retirement years. You can pay less in tax and have more to spend.

    There are many ways you can plan to reduce taxes when you begin withdrawing money. The most common strategy is to delay the start of your Social Security benefits to age 70 while taking IRA withdrawals or using Roth conversions in your 60s. It isn’t the best option for everyone, but for many families, this approach results in less total taxes during retirement years.

    Much of this planning has to do with how other sources of income will affect how much of your Social Security benefits will be taxable. By planning out the timing of those other sources of income, many people can lower their tax bill.

    Recommended Reading: When To Apply For Social Security Disability

    Are Social Security Benefits Taxable

    Approximately 56% of Social Security recipients have to pay income tax on their Social Security benefits.

    Taxation of your Social Security benefits depends on whether or not you have modified adjusted gross income above certain levels after you retire. If you do, figure out your combined annual income by adding your nontaxable interest and half of your Social Security benefits to your adjusted gross income . If youre single and your combined income is between $25,000 and $34,000 a year or if youre married and file jointly and your combined income is between $32,000 and $44,000 a year up to 50% of your Social Security benefits will be taxable.

    However, if youre single and your combined income is more than $34,000 a year or if youre married and file jointly and your combined income is more than $44,000 a year up to 85% of your Social Security benefits will be taxable. No more than 85% of Social Security benefits is ever taxable, regardless of the amount of your modified adjusted gross income.

    Some states also assess state income tax on Social Security benefits. Currently, they include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Vermont, Utah and West Virginia .

    Do You Have To Pay Tax On Social Security

    Americans that are working in retirement, and are making an income when combined with Social security can complicate a tax return.

    If you have managed to retire before your actual retirement age and have begun collecting Social security early, the benefits are subjected to a reduction for beginning early and as your earnings increase. The recipients will have to deal with taxes on some of their benefits if the income exceeds certain amounts.

    Being an early retiree, you have to decide if you should begin getting benefits early. Social security benefits will be reduced if they are started before normal retirement age. If you work, then you are subjected to more reductions. Social security may reduce some of your benefits once you earn over $15,720 in a year. You will lose $1 for ever $2 over this amount. A higher limit will apply to your benefits once your reach full retirement age. If there are any months in the year of your normal retirement that the benefits are reduced more due to the income earned during your early retirement, then your benefits will be increased in later years to make up for the reduction due to those earnings.

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    Taxation Of Social Security Benefits

    Many older Americans are surprised to learn they might have to pay tax on part of the Social Security income they receive. Whether you have to pay such taxes will depend on how much overall retirement income you and your spouse receive, and whether you file joint or separate tax returns.

    Check the base income amounts in IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits. Generally, the higher that total income amount, the greater the taxable part of your benefits. This can range from 50 to 85 percent depending on your income. There is no tax break at all if you’re married and file separate returns.

    The IRS also provides worksheets you can use to figure out what’s taxable and how much you might owe in taxes on your retirement income. You can find these worksheets in IRS Publication 554, Tax Guide for Seniors.

    Withdraw Taxable Income Before Retirement

    How Social Security Benefits are Taxed

    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.

    Read Also: What Documents Have Your Social Security Number

    Other Things To Watch Out For

    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.

    Limit Income From Pretax Retirement Plans

    If you have funds in a pretax plan, such as a 401 or funds in an employer-funded pension, withdrawals you make from these plans after you retire are generally subject to income tax. You can usually have the plan administrator deduct taxes from your distributions but, depending on your tax bracket, it may not be enough to cover your bill.

    Ultimately, your tax rate is based on all your taxable income during the year. If you have multiple sources of retirement income, you’ll save on your taxes in retirement if you limit distributions from pretax plans to only the amounts you need or are required to withdraw.

    Recommended Reading: How Old For Social Security Retirement

    What Is The Additional Medicare Tax

    If youre a high earner, you might owe not only the standard Medicare tax, but also the additional Medicare tax, on some of your earned income for the year. The additional Medicare tax is an extra tax on earned income in excess of the threshold amount for your filing status.

    If youre married and file a joint return, the tax doesnt kick in until your combined earned income exceeds $250,000. But, if youre married and file separate returns, the additional Medicare tax kicks in when either spouse exceeds $125,000 of earned income on his or her income tax return. For singles and heads of household, the threshold is$200,000.

    If you work as an employee, your employer will start withholding for the additional Medicare tax when your earned income at that job exceeds $200,000, regardless of your filing status. You cant request that your employer not withhold until you cross $250,000 if youre married and plan to file a joint return, or request that your employer start withholding once you exceed $125,000 if youre married but will file separate returns. Instead, youll have to make up any underpayment, or receive any excess withheld as a refund, when you file your income taxes.

    There is no additional Social Security tax or any Social Security equivalent to the additional Medicare tax as of 2020.

    Maximize Your Tax Benefits With Roth Ira Distributions

    Retirement tax planning is crucial, so here

    Contributions you make to a Roth IRA account are made with after-tax dollars, and you don’t have the option of deducting these contributions from your income. This makes withdrawals from a Roth IRA during retirement totally tax-free.

    According to IRS enrolled agent Brittany Brown, “Roth IRA withdrawals give the best of both worlds to retirees. You get regular retirement income and no income tax. This is important for seniors because there just aren’t a lot of tax credits or deductions available for people who have unearned income and no longer have dependents to claim.”

    You could increase your retirement income options and decrease your future tax consequences by drawing from a Roth IRA or contributing to a Roth IRA for future use. Also, if you’re still working at retirement age but you’re in a higher tax bracket now than you will be later, limit taking withdrawals from a Roth IRA until you’re at that lower tax bracket.

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    Simplifying Your Social Security Taxes

    During your working years, your employer probably withheld payroll taxes from your paycheck. If you make enough in retirement that you need to pay federal income tax, then you will also need to withhold taxes from your monthly income.

    To withhold taxes from your Social Security benefits, you will need to fill out Form W-4V . The form only has only seven lines. You will need to enter your personal information and then choose how much to withhold from your benefits. The only withholding options are 7%, 10%, 12% or 22% of your monthly benefit. After you fill out the form, mail it to your closest Social Security Administration office or drop it off in person.

    If you prefer to pay more exact withholding payments, you can choose to file estimated tax payments instead of having the SSA withhold taxes. Estimated payments are tax payments that you make each quarter on income that an employer is not required to withhold tax from. So if you ever earned income from self-employment, you may already be familiar with estimated payments.

    In general, its easier for retirees to have the SSA withhold taxes. Estimated taxes are a bit more complicated and will simply require you to do more work throughout the year. However, you should make the decision based on your personal situation. At any time you can also switch strategies by asking the the SSA to stop withholding taxes.

    Make Sure Youre Taking Your Maximum Capital Loss

    If youve invested in stocks or bonds and have a loss on paper, you might want to sell and realize that loss so you can claim it as a tax deduction. The process is called tax-loss harvesting, and it can net you a sizable deduction from your income.

    The tax code allows you to write off up to a net $3,000 each year in investment losses. A write-off first reduces any other capital gains that youve incurred throughout the year. For example, if you have a $3,000 gain on one asset but a $6,000 loss on another, you can claim a deduction for the full $3,000 net loss.

    Any net loss beyond that $3,000 has to be carried forward to future years, at which point it can be used. And even if you cant realize the full value of that net loss, it can still make sense to realize some loss, especially if it pushes your Social Security benefit into the tax-free area.

    Tax-loss harvesting works only in taxable accounts, not special tax-advantaged accounts such as an IRA.

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    Gains Upon The Sale Of Your Home

    You most likely won’t pay taxes on gains from the sale of your home if you’ve lived there for at least two years, unless you have gains in excess of $250,000 if you’re single, or $500,000 if you’re married. The rules get more complex if you rented your home out for a while, so you might want to work with a tax professional to determine whether and how you should report any gains.

    Converting Savings Into A Roth Ira

    Taxes on Social Security Retirement Benefits Explained

    “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.

    Also Check: How Many Social Security Credits Do I Have Now

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