Once You Earn This Much, You Face a Big Tax Bill on Your Social Security Benefits

Many people are surprised to discover that Social Security can sometimes be taxable. Since these are earned benefits that you qualify for by working, you may assume that the funds you start collecting as a senior are yours tax-free.

Sadly, that’s simply not the case for everyone. Once your income reaches a specific threshold, your benefits can become partly taxable. Here’s what you need to know about how taxes on Social Security benefits work.

When do your Social Security benefits become taxable?

The amount of your provisional income determines when you must begin paying taxes on Social Security benefits. Provisional income is different from total income. It equals 1/2 of your Social Security check, all of your taxable income, and some non-taxable income, including interest from municipal bonds.  Based on your provisional income, here’s when you must start to pay taxes on Social Security benefits:

• You owe tax on up to 50% of your benefits if you are a single tax filer with an income above $25,000 or a married joint tax filer with income above $32,000
• You owe tax on up to 85% of your benefits if you are a single tax filer with income above $34,000 or a married joint filer with income above $44,000

Unfortunately, these income thresholds at which benefits become taxable do not just increase over time, unlike many other Social Security metrics, including the amount you can earn before benefits are affected or the amount of monthly benefits you collect (which adjust upward due to Cost of Living Adjustments).  While Social Security has many automatic adjustments built into the program to adjust for the effects of inflation, the income level at which you become subject to tax has not changed since the rules were first created in the 1980s and 1990s.

Because the tax thresholds aren’t indexed to inflation, a growing number of seniors get stuck giving the IRS some of their Social Security benefits every year. Benefits naturally increase over time due to wage growth and COLAs, so seniors can find themselves suddenly over these limits, while more new retirees are subject to them from the start. 

How can you avoid owing taxes on Social Security benefits?

The only real way to avoid taxes on Social Security benefits is to keep your provisional income below the thresholds. While the thresholds are fairly low, this isn’t necessarily as hard as it might seem if you begin planning early. That’s because you can choose to invest in Roth accounts instead of traditional ones, and distributions from a Roth account do not count in your provisional income.

If you are already in or near retirement, however, a Roth conversion can have major financial consequences, both because it is a taxable event and because of a five-year rule that could limit your ability to withdraw funds within five years of the conversion. If you are already in retirement and over the limits where benefits become taxed, you’ll likely simply have to accept giving the IRS a cut unless you can employ other strategic moves like tax loss harvesting to consistently stay below the limits.

A financial advisor can help you understand if you are likely to owe tax on Social Security benefits, can help you reduce the likelihood you’ll be taxed, and can also work with you to make your Social Security benefits stretch as far as possible, regardless of whether you keep every dollar or must send some to the government.