Retirees who have several sources of income, including pensions, retirement account withdrawals or part-time work, might have to pay taxes on part of their Social Security benefit. The federal government taxes up to 85% of Social Security payments for seniors who earn more than a specific threshold, but never taxes the full benefit.
Here's how to tell if your Social Security benefit is taxable:
-- Individuals with a combined income between $25,000 and $34,000 are taxed on 50% of their Social Security benefit.
-- If your combined income exceeds $34,000, 85% of your Social Security income could be taxable.
-- Married couples face tax on 50% of their Social Security benefit if their combined income is between $32,000 and $44,000.
-- Up to 85% of Social Security income is taxable for married couples with a combined income that exceeds $44,000.
Is My Social Security Income Taxable?
If Social Security is your only source of retirement income, you aren't likely to have to pay taxes on it. The average Social Security payment in January 2021 was $1,543 for retired workers and $2,596 among married couples who are both receiving benefits, which is below the threshold for taxation of Social Security benefits. However, if your combined income, or the sum of your adjusted gross income, nontaxable interest and half of your Social Security benefit, is more than $25,000 as an individual and $32,000 as a married couple, you will need to pay federal income taxes on part of your Social Security income.
Calculating Your Social Security Tax Rate
If your combined income is between $25,000 and $34,000 ($32,000 and $44,000 for couples), you could owe income tax on as much as 50% of your Social Security benefit in retirement. When your income exceeds $34,000 ($44,000 for couples), you may need to pay income tax on as much as 85% of your Social Security income. These income cutoffs are not adjusted for inflation each year.
Social Security recipients receive a Social Security Benefit Statement , Form SSA-1099, each January, which lists the benefits received over the past year. This document can be used to find out the total amount of your annual Social Security payments and calculate if your Social Security benefit will be subject to tax. You can also find this form in your my Social Security account under the "replacement documents" tab.
Withholding Federal Taxes From Your Social Security Benefit
Those who owe Social Security taxes can make quarterly estimated tax payments to the IRS or elect to have federal taxes withheld from their benefit by filling out IRS Form W-4V. "I encourage people to make their life easier and just have it withheld from their checks," says Scott Newhouse, a certified financial planner for Forthright Finances in Thousand Oaks, California. "Making quarterly payments is an extra thing to keep track of." You can choose to have 7%, 10%, 12% or 22% of your monthly Social Security benefit withheld for taxes.
State Taxes on Social Security Income
Most states don't tax Social Security income, but a few do. States that tax Social Security income include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia, according to state tax research from Wolters Kluwer. In some cases, lower-income seniors may not be subject to the Social Security tax.
"There are some states that don't have an income tax, and then there are 37 states that don't tax Social Security benefits at all. In a couple of states, there is a partial exception," says Barbara Weltman, an attorney and author of "J.K. Lasser's 1001 Deductions and Tax Breaks 2021." "You have to check with your state. For the vast majority, there is no income tax on Social Security benefits at the state level, even if it is taxed at the federal level."
Minimizing Social Security Taxes
There are several strategies retirees can use to stay below the thresholds for Social Security taxation. Retirees can take large individual retirement account withdrawals in the years before signing up for Social Security, and then take smaller distributions after enrolling in Social Security in order to minimize taxable income. If you donate a required minimum distribution from your IRA to charity, the withdrawal is not counted as income and doesn't contribute to the taxation of Social Security benefits.
Earned income from a part-time job can push you above the threshold for Social Security taxation. "When you are trying to make your decisions about when to take Social Security, take tax into account as a factor," says Alexandra Baig, a certified financial planner for Companions On Your Journey in Brookfield, Illinois. "If you are still working, it's probably a good idea to delay taking your Social Security."
Saving for retirement in a Roth IRA or Roth 401(k) or converting your savings to a Roth account can also help you manage your Social Security tax bill, because distributions are not considered taxable income.
"The Roth IRA can be a very powerful tool to help you minimize Social Security taxation," says Todd Porterfield, a certified financial planner and founder of Fairchild Capital in Portland, Oregon. "Funds that are distributed from your Roth IRA are not counted as part of the combined income."