Many U.S. retirees think Social Security is not taxable. That is partly true, Social Security income is typically not taxable, unless your other income is too high. About 25 million Americans pay income taxes on their Social Security benefits. Having to pay tax on their Social Security benefits can be an unpleasant surprise for many seniors who were planning on their Social Security benefits as a source of tax-free income. Depending on your other income, you could pay tax on 50 or 85 percent of your benefits.
As you prepare for retirement, it’s essential to determine if your Social Security benefits will be tax free or vulnerable to a tax hit, which will reduce your available cash to live on. The first step to determine if your Social Security is taxable is to compute your “Provisional Income,” which is basically your adjusted gross income plus any tax-exempt interest and 50 percent of your benefits (Note, there are other items of income added to determine Provisional Income not discussed herein). For a single taxpayer, if your Provisional Income exceeds $25,000, 50 percent of your Social Security is taxable. If more than $34,000, 85 percent is taxable. For a couple, when Provisional Income exceeds $32,000 on a joint return, 50 percent of their Social Security is taxable. If your Provisional Income exceeds $44,000 on a joint return, 85 percent of their benefits will be taxed. The threshold is 0 for married couples who file separate returns, causing 85 percent of their benefits to be taxable.
Having part of your Social Security become taxable can substantial increase your tax bill.
For example, let’s say your AGI is $80,000 and you and your spouse receive a total of $25,000 in benefits. The maximum 85 percent ($21,250) would be taxed, costing you $5,312.50 in extra federal income tax in the 25 percent bracket. That reduces your available Social Security benefit by more than 20 percent.
You may be able to limit the tax bite with some tax planning. Where possible, by planning the timing the receipt of income, you may be able to avoid taxes on your Social Security. Timing the sale of stocks or other appreciated property can pay off. By shifting profits to years when 50 or 85 percent of your Social Security benefits will be taxed anyway, away from years when your Social Security benefits that will not be taxed can result in substantial tax savings. If you Convert a Traditional IRA to a Roth IRA, the Roth IRA tax free income can reduce your Provisional Income and help avoid your Social Security being taxed..
These strategies can be more important than they appear. Say you’re single and your Provisional Income is $25,000, and you add $100 to your Provisional Income for a total of $25,100. The extra $100 income will cause 50 percent of otherwise tax-free Social Security benefits to be taxable, resulting in an increase in your tax bill. If your your Provisional Income was $25,100 and you reduced it by $100, 50 percent of you Social Security would not be taxable. By reducing Provisional Income by $100, your Social Security is non taxable, resulting in a nice tax savings.
I have always had a problem with Social Security being taxable. To fund our Social Security benefit, we pay a Social Security Tax. If our Provisional Income is too high, we have to pay income taxes on 50 to 85 percent of the benefit we received. A percentage of this benefit has already been taxed. Isn’t this double taxation?
Under the Obama administration, Social Security some how became an entitlement. I do not understand why Social Security should be treated as an entitlement or welfare program. It is my money that I paid into the system that I am getting back. But, what do I know.
Not withstanding my opinion, if your income is too high, part of your Social Security will be taxable.
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Author’s email: wolff2000@earthlink.net
