Social Security can sometimes feel like an enigma. When you’re working, it’s simply a line item your company withholds from your paycheck, so it’s likely not top of mind. At least, not until you start thinking about retirement.
And planning for how Social Security benefits will impact your retirement plan can be downright complicated! When should you enroll? How much are you eligible for? What does it mean for your taxes?
In fact, a study found that only 3% of people 55-65 can answer 12 true or false questions about the program correctly. So, there’s clearly a significant gap in knowledge of what Social Security is and how it works.
We’re here to help! Throughout our extensive financial planning experience, we’ve noticed that many retirees get confused by Social Security, especially regarding how it impacts their taxable income.
Today, we’re going to answer a specific question regarding these puzzling yet poignant benefits:
How is Social Security taxed?
How Do I Know If I Need To Pay Taxes On My Social Security Benefits?
The Social Security Administration (SSA) reports that about 40% of people have to pay income taxes on their Social Security benefits. You will likely have to pay federal income taxes on your Social Security benefits if you have other sources of substantial income, like:
- Wages (from continued work)
- Self-Employment
- Interest (from investments)
- Dividends & Capital Gains (the IRS considers this “portfolio income”)
SSA will be in contact annually to give you a summary of your benefits from that year, known as Form SSA-1099. You will use this statement to find out if you’re required to pay taxes on your benefits.
Here’s where you have to wade through some lingo.
The Social Security Administration (SSA) uses your “combined income” to help determine whether or not you’ll owe taxes. The recipe for “combined income” includes,
- Your adjusted gross income (AGI) – This is calculated by taking the sum of all of your taxable income sources and subtracting your allowable deductions and expenses.
- Nontaxable interest
- One-half of your Social Security benefits
Once you know your combined income, the SSA compares that number to your “base amount,” which you can find in IRS Publication 915. Check their website for updated numbers on the 2022 tax season.
You’ll likely owe taxes on your benefits if your “combined income” exceeds the base amount allowable for your tax filing status.
Since this stuff gets super in the weeds, it’s often best to consult a professional to be confident you’re working with the most accurate numbers.
How Much Tax Will You Owe On Your Benefits?
If you have to pay taxes on your Social Security benefits, it may be a higher percentage than you want—up to 85% of your benefits could be taxable depending on your and your spouse’s income. This doesn’t mean you’ll be paying 85%, but rather 85% is added to your taxable income.
SSA outlines the following thresholds for both individuals and married couples to determine if your benefits will be taxed:
- If you file your federal tax return as an individual:
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- If your combined income is between $25,000 and $34,000 = Up to 50% of your benefits may be taxed
- If your combined income is more than $34,000 = Up to 85% of your benefits are subject to income tax
- If you file your federal tax return jointly with your spouse:
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- If your combined income is between $32,000 and $44,000 = Up to 50% of your benefits may be taxed
- If your combined income is more than $44,000 = Up to 85% of your benefits are subject to income tax
- If you’re married and file a separate federal tax return:
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- SSA estimates that you’ll likely have to pay taxes on your benefits.
Who Has To Pay The Tax?
The answer to this question is relatively simple.
When determining your taxable income, SSA benefits fall into the taxable income of the person with the legal right to receive the benefits.
Now, let’s say you receive your Form SSA-1099 and find that you have to pay taxes on your benefits, how do you go about doing that?
How Do I Pay Social Security Taxes?
Just like when you were employed, you can automatically elect to have federal income tax withheld from your social security benefits. To do this, you must complete a Voluntary Withholding Request, aka Form W-4V.
If you decide not to enroll in automatic withholdings, you may have to request additional withholding from your other sources of income or pay estimated quarterly taxes throughout the year. This is similar to how a business owner pays their taxes.
The IRS provides Form 1040-ES to help you determine your estimated tax amount and report your benefits.
Which Method Should I Use?
Having federal income tax withheld from your benefits is likely more convenient than making quarterly estimated tax payments.
However, the IRS recommends that you consider making estimated tax payments if you have other sources of significant income that aren’t subject to withholding.
If you decide to withhold taxes from your benefits, you have the option to decide how much. You may withhold 7%,10%, 12%, or 22% from each Social Security payment. To help determine how much you should withhold, you can check back in with the worksheet on Form 1040-ES.
Are Other Social Security Benefits Taxable?
In addition to retirement benefits, SSA also provides Spousal Benefits, Survivor Benefits, Disability Insurance Benefits, and Supplemental Security Income.
Out of those programs, Spousal, Survivor, and Disability Benefits are all taxable, just like the traditional retirement benefits.
The taxable amounts, income thresholds, and other guidelines remain consistent between the taxable programs.
How Do Social Security Taxes Impact My Retirement Income Plan?
Unfortunately, tax laws are something that we don’t have the power to control. But, what we can do, is plan ahead!
Maximizing your income in retirement is important, and that includes your Social Security benefits. Do some work ahead of time by estimating your retirement income to determine what threshold you may (or may not) be taxed at. From there, work that taxable amount into your retirement income plan.
If you’re concerned about the IRS eating up your Social Security benefits, please reach out to a financial professional for help. Your financial advisor can help you brainstorm ways to cushion your retirement nest egg, like maximizing your Roth IRA accounts, tax loss harvesting, asset location, and more.
The best way to stay on top of your retirement income is to start planning early. Please reach out to us today to schedule an appointment. We’re looking forward to working with you.
