Taxation of Social Security Benefits

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Keep an eye on your income amounts when claiming Social Security

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Many people are often surprised to learn that once they are retired and start collecting Social Security that they may have to pay taxes on their benefit.  Throughout our working career we have probably all seen the money that gets deducted to fund Social Security. However, when you start drawing your Social Security benefit there is a strong likelihood that you will have to pay taxes on a portion of that income.  These numbers have not been adjusted for inflation and with higher balances in retirement plans and a rising stock market this can lead to more taxation. Also, with retirees taking part time work while on Social Security, those amounts can also increase income making more Social Security taxable. 

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Calculation for taxable amount

The first step in determining whether any portion of Social Security is taxable is to calculate what they refer to as “provisional income.” This income is can be thought of as a combination of different income sources.  This income consists of:

  • Adjusted Gross Income
  • Any tax-exempt interest income, example municipals bonds
  • Half of any Social Security benefits

 

Once this amount is calculated it is then compared to the income threshold amounts. 

For single taxpayers:

            Income below $25,000 Social Security is tax free

Income between: $25,000 – $34,000 and 50% of the Social Security benefit is taxed

Income above $34,000 results in up to 85% taxable

For married filing jointly:

            Income below $32,000 Social Security is tax free

            Income between $32,000 – $44,000 up to 50% of Social Security benefit is taxed

            Income above $44,000 up to 85% of Social Security benefit is taxed

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One thing to keep in mind is what is all included in your Adjusted Gross Income, by definition gross income includes your wages, dividends, capital gains, business income, retirement distributions as well as other income. Adjustments to your gross income includes, alimony, student loan interest, educator expenses and contributions to a retirement account. 

Here is a quick example of how the taxes would work on a Social Security benefit.

Steve and Mary have an AGI of $27,000 and also have municipal bond interest of $1,000. Their Social Security amount is $20,000 per year. Therefore, to calculate what amount may be taxable they would add $27,000 + $1,000 + $10,000(one half of benefit) = $38,000 of combined income. This is $6,000 over $32,000 threshold, therefore, $3,000(50% of $6,000) of their benefit amount is taxable.

 

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One way that you could potentially reduce the taxes you pay on your Social Security benefit is to convert your pretax retirement accounts into a Roth IRA. This would need to be done before you start claiming your Social Security benefit.  This would cause you to pay taxes in the year that you converted, however, if this is before you start claiming Social Security this amount would no longer be included in your pretax account. As long as the Roth IRA is opened for a least 5 years, and you are over the age of 59.5 any withdrawal from that Roth IRA would not be included in income for that year. Therefore, this amount would not be used in the calculation for your taxable Social Security amount. 

 

Keep in mind you can check you Social Security statement which shows the amount of your future benefit by logging into www.ssa.gov

 

 

 

 

 

 

If you would like to schedule a call or zoom meeting to discuss a review of your investments Click Here

 

 

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