A lot of people end up relying heavily on Social Security for income in retirement. And unfortunately, folks in that boat often get an unpleasant surprise when they learn that Social Security benefits can be subject to taxes.
Will your benefits be taxed, though? It depends on your income.
How Social Security taxes on benefits work
If the idea of being taxed on your Social Security benefits in retirement doesn’t sit right with you, you’re not alone. After spending your entire career paying into the program via payroll taxes, you’d think those benefits would be yours free and clear.
Unfortunately, taxes can apply to Social Security benefits at the federal level depending on your income. And some states impose their own taxes, too (though most don’t, and of the ones that do, some have exemptions for low or moderate earners).
To see if you’ll be taxed on your Social Security benefits in retirement, you’ll need to calculate your combined income. Combined income is the total of:
- 50% of your annual Social Security benefit
- Your adjusted gross income
- Non-taxable interest you earn, such as interest from municipal bonds
From there, whether you’ll pay taxes on your Social Security benefits depends on your filing status.
If you’re filing as an individual, a combined income between $25,000 and $34,000 means you may have to pay taxes on up to 50% of your Social Security benefits. If your combined income goes beyond $34,000, you’re potentially looking at taxes on 85% of your benefits.
These numbers change slightly if you’re married filing a joint tax return. In that case, a combined income of $32,000 to $44,000 means you could face taxes on up to 50% of your Social Security benefits. Beyond $44,000, you could face taxes on up to 85% of your benefits.
The thresholds aren’t that large
You may be noticing that the combined income thresholds above aren’t very large. And the reason is that they were established decades ago and have not been adjusted for inflation — a point that many find infuriating.
That said, as part of his campaign, President Trump said he’s looking to get rid of taxes on Social Security benefits. So there’s a chance that these stingy combined income limits may not be a point of concern at some point down the line.
For now, though, the rules dictating whether Social Security benefits are taxed or not are sticking. So if you’re gearing up for retirement, it’s important to understand how taxes on benefits work so you can plan accordingly.
To that end, it’s a good idea to sit down with a financial advisor and map out a retirement budget based on your various income sources and the extent to which they may be taxable. An advisor can also give you tips on how to reduce your overall tax burden as a retiree.
There are also certain moves you can make ahead of retirement to reduce the likelihood of having to pay taxes on your Social Security income specifically, like moving your savings into a Roth IRA.
Roth IRA distributions don’t count toward combined income, so keeping money in one of these accounts could work to your advantage in more ways than one. And the sooner you meet with an advisor, the more strategies they can share along these lines.
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