If You Earn Enough Money For Your Benefits To Be Taxable You Could End Up Paying The Highest Income Taxes In The Country
By Stephen Fishman, J.D.
Social Security benefits are tax free unless you earn too much income during the year. To know whether you might be subject to such taxes you have to figure your “combined income.” This is actually quite easy: Simply add one-half of the total Social Security you received during the year to all your other income, including any tax-exempt interest .
You’ll have to pay tax on part of your benefits if your combined income exceeds these thresholds:
- $32,000 if you’re married and file a joint tax return , or
- $25,000 if you’re single.
If a married couple files their taxes separately, the threshold is reduced to zerothey always have to pay taxes on their benefits. The only exception is if they did not live together at any time during the year in this event the $25,000 threshold applies.
This applies to all types of Social Security benefits: disability, retirement, dependents, and survivors benefits.
How much of your Social Security benefits will be taxed depends on just how high your combined income is.
Individual filers. If you file a federal tax return as an individual and your combined income is between $25,000 and $34,000, you have to pay income tax on up to 50% of your Social Security benefits. If your income is above $34,000, up to 85% of your Social Security benefits is subject to income tax.
Once you start receiving Social Security benefits, to keep your income below the applicable threshold, or at least as low as possible, you should:
Proposals To Reduce The Taxation Of Benefits
Despite the strong rationale for taxing a portion of Social Security benefits, some members of Congress from both sides of the aisle have proposed scaling it back. These proposed changes would reduce Social Security revenues, worsening the programs long-run financial shortfall and requiring additional tax increases or benefit cuts to restore long-run solvency. In addition, they would make the system of Social Security benefits and taxes less progressive.
Former Rep. Sam Johnson, who chaired the Social Security Subcommittee when Republicans controlled the House, proposed scaling back the taxation of benefits as part of a bill to restore Social Security solvency by cutting scheduled benefits. Johnsons bill would have phased out the portion of the taxation of benefits that is credited to the Social Security trust funds. That provision would have increased Social Securitys 75-year shortfall by 17 percent , according to the Social Security actuary.
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How To Plan For Social Security Taxes
A balanced approach to distribution is the best way to plan for Social Security taxes, says Freitag. Keep in mind that too much emphasis on one type of distribution or another is not the way to go.
It is better to have a mix of income streams in retirement, he says. As an example, if all your income is taxable, then adding Social Security just makes it worse across the board.
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Tips For Saving On Taxes In Retirement
- Finding a qualified financial advisor doesnt have to be hard. Finding a qualified financial advisor doesnt have to be hard. SmartAssets free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If youre ready to find an advisor who can help you achieve your financial goals, get started now.
- What you pay in taxes during your retirement will depend on how retirement friendly your state is. So if you want to decrease tax bite, consider moving to a state with fewer taxes that affect retirees.
- Another way to save in retirement is to downsize your home. Moving into a smaller home could lower your property taxes and it could also lower your other housing costs.
How The Earnings Limit Is Applied
The most confusing part of the benefit reduction due to income is how its reflected in your monthly benefits deposits. Instead of taking out a little bit every month, the SSA will withhold several months of benefits at a time.
If you predict in advance that you will have excess earnings and report this to the Social Security Administration, they may take a few months of benefits before you actually earn the anticipated excess earnings.
For example, if your Social Security payment is $1,667 per month, and you expect to receive $28,960 in wages from your job, the Administration would calculate that youll be over your earnings limit by $10,000 and thus $5,000 in benefits should be withheld. So, they would withhold your benefit payment from January to March. In April, your checks would resume.
If you dont report excess income before you earn it, then you have to report this information after the fact. You can do this when you file your income tax return, but the preferred method is to be proactive and call your local Social Security Administration office.
If you wait for the Social Security Administration to learn of your excess earnings via your tax return, there could be a significant gap between the time you earn the excess income and the time that they withhold your benefits. In most cases, its better to report the excess earnings quickly so the benefits reduction occurs closer to the time you actually earn that extra income.
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.
Next Steps To Consider
A qualified distribution from a Roth IRA is tax-free and penalty-free, provided the 5-year aging requirement has been satisfied and one of the following conditions is met: age 59½ or older, disability, qualified first-time home purchase, or death.
This information is intended to be educational and is not tailored to the investment needs of any specific investor.
Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.
Investing involves risk, including risk of loss.
Past performance is no guarantee of future results.
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Taxes On Pension Income
You have to pay income tax on your pension and on withdrawals from any tax-deferred investmentssuch as traditional IRAs, 401s, 403s and similar retirement plans, and tax-deferred annuitiesin the year you take the money. The taxes that are due reduce the amount you have left to spend.
You will owe federal income tax at your regular rate as you receive the money from pension annuities and periodic pension payments. But if you take a direct lump-sum payout from your pension instead, you must pay the total tax due when you file your return for the year you receive the money. In either case, your employer will withhold taxes as the payments are made, so at least some of what’s due will have been prepaid. If you transfer a lump sum directly to an IRA, taxes will be deferred until you start withdrawing funds.
Smart Tip: Taxes on Pension Income Vary by StateIts a good idea to check the different state tax rules on pension income. Some states do not tax pension payments while others doand that can influence people to consider moving when they retire. States cant tax pension money you earned within their borders if youve moved your legal residence to another state. For instance, if you worked in Minnesota, but now live in Florida, which has no state income tax, you dont owe any Minnesota income tax on the pension you receive from your former employer.
Avoiding Social Security Benefit Taxes
You might be able to tweak your spending if your combined income is close to the taxation thresholds listed above to reduce or avoid taxes on your Social Security benefits. Consider cutting back on spending or withdrawing more money from your Roth savings, if you have any, because this money does not count toward your combined income for the year. Charitable donations will also help reduce your combined income because you can write these off on your taxes.
If you’re still working, consider delaying Social Security until you retire. This could help lower your combined income because you stop getting paychecks, which in turn might help you avoid Social Security benefit taxes. It’ll also help boost your Social Security checks when you do finally begin claiming them. But don’t delay your Social Security benefits past age 70. Your checks won’t increase anymore after this, and avoiding Social Security benefit tax isn’t worth giving up all the money your Social Security checks could provide.
Social Security benefit taxes aren’t the easiest thing to understand, but it’s important that you take the time to learn the rules. It can help you make more educated decisions about your Social Security benefits and your retirement savings so you can hold on to more of your hard-earned cash.
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Need More Information On Social Security
If you still have questions, you could leave a comment below, but what may be an even greater help is to join my.
Its very active and has some really smart people who love to answer any questions you may have about Social Security. From time to time Ill even drop in to add my thoughts, too.
You should also consider joining the 326,000+ subscribers on myYouTube channel! For visual learners , this is where I break down the complex rules and help you figure out how to use them to your advantage.
One last thing that you dont want to miss: Be sure to get your FREE copy of mySocial Security Cheat Sheet. This handy guide takes all of the most important rules from the massive Social Security website and condenses it all down to just one page.
Up To 85% Of A Taxpayer’s Benefits May Be Taxable If They Are:
- Filing single, head of household or qualifying widow or widower with more than $34,000 income.
The Interactive Tax Assistant on IRS.gov can help taxpayers answer the question Are My Social Security or Railroad Retirement Tier I Benefits Taxable?
The tax filing deadline has been postponed to Wednesday, July 15, 2020. The IRS is processing tax returns, issuing refunds and accepting payments. Taxpayers who mailed a tax return will experience a longer wait. There is no need to mail a second tax return or call the IRS.
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Planning For Gifts And Bequests
As you look ahead, you may be thinking about giving some of your assets to family members or friends, which is often beneficial to both you and them as long as you can afford to live comfortably on your remaining retirement income.
Transferring wealth is often a good way to avoid incurring estate taxesand that’s in turn good because these taxes can take a larger bite of your assets than even the highest income tax rate. In addition, some states impose inheritance taxes at various rates on what your heirs receive from your estate.
But the good news is that prior to your death, you can make gifts to whomever you wishand you can do so up to a certain amount without paying taxes. The IRS ceiling for individuals and married taxpayers changes from time to time.
In addition, you can make larger gifts tax-free to your beneficiaries over the course of your lifetime. You have to follow IRS rules carefully to comply with the lifetime exclusion provisions. For more details, read the instructions for IRS Form 709.
There are pros and cons to making tax-free gifts. On the upside, giving the money away reduces your taxable estatethat is, what will be subject to estate taxes when you diewhile also helping your beneficiaries. But on the downside, once the gift is given, if you need access to that money later in your retirement, it’s gone.
How Much Of Your Benefits Are Taxable
The amount of Social Security benefits that are taxable depend on the extent to which your income plus half of your benefits exceed certain base amounts. There are 2 possibilities:
- 50% of benefits taxed. This is the amount of benefits that will be taxed if your income plus half of your benefits exceeds these base amounts:
- $25,000 if single, head of household or qualifying widow
- $25,000 if married, filing separate and lived apart from spouse all of the tax year
- $32,000 if married, filing jointly
- NOTE: These base amounts are the same ones described earlier.
- 85% of benefits taxed. This is the amount of benefits that will be taxed if your income plus half your benefits exceeds these adjusted base amounts:
- $34,000 if single, head of household or qualifying widow
- $34,000 if married, filing separate, and lived apart from spouse for entire year
- $44,000 if married, filing jointly
- $0.00 if married, filing separate and lived with spouse at any time
- NOTE: The adjusted base amount essentially allows the IRS to tax more of your Social Security benefits as income goes up.
One Married Couple’s Tax
The following scenarios illustrate how taking Social Security benefits early versus delaying until age 70 affects the federal taxes of this married couple, who are both age 62.
Scenario 1: Taking benefits at age 62
Michael and Patricia anticipate a pre-tax retirement income of $75,000, consisting of $24,000 from their Social Security benefits and $51,000 in taxable distributions from their IRAs.
Based on their earnings history at age 62, 85% of their Social Security benefits would be taxable.
Assuming no other income and using the standard deduction, Michael and Patricia would owe $5,307 in federal taxes. Their after-tax income is $69,693.
Scenario 2: Delaying benefits until age 70
In the years between their retirement and age 70, Michael and Patricia would need to take additional taxable distributions from their IRAs.
But at age 70, they’d receive $42,240 in Social Security benefits, meaning they’d need only $32,760 in IRA withdrawals, including required minimum distributions .
Using the same assumptions , only 34% of the couple’s Social Security benefits would be taxable, and their federal taxes would total $2,086. Their after-tax income would be $72,914.
In this scenario, their total taxes would be slightly higher in the years before they claim Social Security benefits, but lower taxes after age 70 would offset the initial tax cost in less than 2 years.
Social Security claiming strategies at a glance
What Is The Net Investment Income Tax
If youre someone with substantial investment income including capital gains passive income, certain annuities, dividends, interest, rents, and royalties you may have to pay an additional tax that goes toward supporting Americas healthcare program.
The Net Investment Income Tax applies a flat rate of 3.8% to your investment income if your adjusted gross income is above the following amounts for your filing status:
- Single and head of household: $200,000 or more
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How Is Social Security Taxed
A retiree’s provisional income is used to determine the tax owed on their Social Security benefit.
Provisional income is equal to adjusted gross income plus non-taxable interest plus half of annual Social Security benefits.
That total is then applied to the following income limits to determine how much of the Social Security benefit will be taxed at the filer’s marginal tax rate:
|Provisional income for a single, head of household, or qualifying widow filer||Provisional income for a married, joint filer||Amount of Social Security benefit taxed|
|85% of Social Security benefit taxed at filer’s marginal tax rate|
Donate Your Required Minimum Distribution
If you cant wiggle out of taking your RMD from a traditional IRA, then donate it to charity to get into the tax-free zone. The donation could allow you to deduct the amount from your adjusted gross income. But youll have to be eligible for the qualified charitable distribution rule, including being over age 70 ½ and paying the distribution directly from the IRA to the charity.
Thats a strategy that Crane suggests, though he acknowledges that some people will have too much income and simply wont be able to lower their adjusted gross income.