By Ryan Wisniewski
For many, social security retirement benefits are a significant source of income in retirement, although it is not typically the only source. How much of your social security income is subject to income tax, depends on how much total income you have during the year. Anywhere from 0% to 85% of your social security income can be subject to tax. It is important to know when social security retirement benefits are taxable so that you can plan accordingly for income tax withholding and/or quarterly estimated tax payments. The taxability of this income can also play an important role in your overall retirement planning.
If your “provisional income” exceeds certain levels, a portion of your social security retirement benefits will be taxable. Provisional income is calculated by adding the following:
- Modified Adjusted Gross Income (in most instances this equals your Adjusted Gross Income),
- plus: 50% of your total social security benefits,
- plus: 100% of tax-exempt interest income
If your provisional income exceeds specified threshold amounts, anywhere from 50% – 85% of your annual social security benefits can be taxable.
The specified threshold amounts for various filings statuses are:
- Married Filing Joint – 50% of social security income taxable when provisional income exceeds $32,000; 85% taxable when provisional income exceeds $44,000.
- Single, Head of Household, Qualifying Widower, or Married Filing Separate – 50% of social security income taxable when provisional income exceeds $25,000; 85% taxable when provisional income exceeds $34,000.
There are several solutions to limiting the taxability of your social security retirement benefits. These include, but are not limited to:
- Keeping some retirement assets in Roth accounts. Since distributions from Roth accounts are tax-free, assuming they are withdrawn after age 59.5, the amounts do not add to your provisional income.
- Grouping income-producing events into one-year. If, for example, you have an income event in January 2021 which will inevitably push your provisional income over the threshold that would cause your social security income to be 85% taxable, and you know you will have a similar event in January 2022, perhaps you can accelerate that event into December 2021. This will leave the potential that your 2022 social security income might not reach that 85%, or even that 50%, level of taxability.
- Withdraw taxable retirement funds prior to applying for social security benefits. Not only will this help with funding your living expenses prior to applying for social security benefits, but your monthly benefits will increase the further you push out taking social security benefits, at least until age 70.
- Reduce debt prior to retirement. If you can reduce or eliminate debt, your cash flow needs will be less, and the amount of income necessary will decrease. Absent of required minimum distribution rules, this could help to reduce or eliminate the taxability of your social security income.
While social security retirement benefits will remain an integral part of retirement income for many, the importance of managing the taxability of such income is very important. In collaboration with your personal financial advisor and investment advisor, your trusted CPA can help to evaluate your options, so that you are not caught off-guard with taxes you did not anticipate paying.
Please consult your R+R tax advisor for more information.
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