A question which often arises among those who are thinking about retirement is, “Will my Social Security income be taxed?” Generally speaking, the answer to this question is yes; however, there are deviations from this. Previously, Social Security income was not taxable. But things have changed. Everyone drawing Social Security gets 15% of their benefits tax-free. After this percentage, things change. If you rely exclusively on Social Security for your income, your entire benefits should be non-taxable. However, if you fall in the bracket of people who receive income from other outlets such as a 401(k), a pension, or a part time job, you are receiving more than the Social Security Administration limit allows for tax free-benefits and therefore up to 85% of your Social Security could be taxed.
IRS Income Limits:
As of 2015, the IRS limits for configuring tax liability of your Social Security income are as follows:
A person filing individually with a combined income (your Adjusted Gross Income + Nontaxable Interest + 1/2 of your Social Security benefits.) within the financial bracket of $25,000-$35,000 must pay income tax on up to 50% of their Social Security benefits. If an individual has a combined income of $34,000 or more, they will be required to pay income tax on 85% of the Social Security benefits.
For married couples who are filing together, if their combined income is between $32,000 and $44,000, they will be required to pay taxes on up to 50% of their benefits. If, however, their combined income is more than $44,000, they must pay taxes on 85% of the Social Security.
As of right now, no one pays taxes on more than 85% of their Social Security benefits no matter their financial bracket.
The monthly Social Security check averages around $1,294. This is an annual income of approximately $15,528. If your benefits are near average and this is your sole income, you will not have to pay any taxes on your Social Security. If you are not sure about your Social Security income you can consult form SSA-1099 for a summary of your benefits.
Federal Taxes on Social Security Income:
For those who have figured out that they will need to pay taxes on their Social Security, the tax rate is the same as regular income. To break it down, for every dollar over $25,000 that an individual makes, $.50 of their Social Security benefits could be subject to federal taxation. This number rises to $.85 when an individual claims an income over $34,000.
If 50% of your benefits are subject to taxation, the amount you include in your taxable income will be the lesser of either (a) half of your annual benefits or (b) half of the difference between your combined income and IRS threshold. However, if you figure out that 85% of your benefits are subject to taxation, things can get even more complicated. In order to help you better understand the tax liability on your Social Security, it is advisable to check into the worksheet and e-file software provided by the IRS. These sheets will help you to better calculate and understand your income tax.
The Impact of Roth IRAs:
Based upon the information above, you may be a little concerned about the taxes you will have to pay once you are in retirement. If this is the case, you might consider saving your money in a Roth IRA. With this type of IRA, you save after taxes. With a traditional IRA you will be required to take Required Minimum Distribution; however, with a Roth you have already paid the taxes on that money.
Because of this, a Roth IRA will not add to your provisional income; therefore, such an account will allow to draw additional income without going over the IRS threshold concerning Social Security.
You Can Make Social Security Taxes a little Simpler:
There are ways to avoid the shock of paying a large amount of taxes in one large lump. First, you can ask the Social Security Administration to withhold taxes from checks. This is simply done by submitting a IRS W-4V form. Second, you can pay your taxes on quarterly basis just like you would taxable investments.
State Taxes on Social Security Benefits:
Another question you may be asking concerning Social Security is how it works with state taxes. Will you have to pay state taxes based upon your Social Security income? This is a rather complicated question due to varying rules throughout the 50 states and the fact that some states offer exemptions and credits based upon age or income.
A majority of States exempt some Social Security income from their taxes, while states such as Alaska do not tax income at all. However, there are a handful of states which tax Social Society benefits to the extent that they are at the federal level. The best way to know the specifics concerning state tax is to check with your local authorities. As with federal taxes, if Social Security is your only source of income, you are exempt from paying taxes on your benefits
Although none of us enjoy paying taxes, there is a bright side: if you are having to pay taxes on your retirement, this means you are doing well. You are receiving income from other outlets
and not relying solely on your Social Security. Even though you may have to pay some taxes, having other financial outlets outside Social Security will provide more security in the long run.