When calculating the amount of money you will have during retirement, what most people fail to properly calculate is the amount of taxes they will have to pay and how it will negatively affect their benefits. Most states do not tax Social Security benefits, but federal taxes are not as lenient, as there are some cases in which your benefits may be taxed.
For individuals exceeding a certain income threshold, up to 50% of benefits could be taxed, and for those who are even higher earners, up to 85% of benefits could be taxed. Most people who receive Social Security benefits will not have to worry about this, but for some, there is some information they should be aware of.
Determining the Taxable Amount of Social Security
To determine whether and to what extent your benefits will be subject to taxation the Internal Revenue Service (IRS) uses what is called combined income. This is the sum of your adjusted gross income (AGI), non-taxable interest, and 50% of your Social Security benefits. AGI is your income from all sources, such as wages, salaries, dividends, capital gains, business, and other earnings, minus the deductions the IRS allows. Non-taxable interest form things like bonds must be included because they are resources available to you even if they are not taxed directly.
After you have determined the total sum, you will need to compare it against the IRS income thresholds to determine the taxability of your Social Security benefits. These thresholds are meant to protect lower-income retirees from being taxed on their benefits and are updated (although not as often as they should) to ensure that only those in the upper echelons pay taxes on benefits. The thresholds are the following:
- Single filers: $25,000 and $34,000
- Married filing jointly: $32,000 and $44,000
- Married filing separately: $0 (if you lived with your spouse at any time during the year)
Other filing statuses, such as head of household or qualifying widow(er), generally follow the thresholds for single filers.
If the amount is lower than the first threshold, you will not have to pay taxes on your benefits. If it falls between the thresholds, you will have to pay taxes on half of your benefits and if it exceeds the upper thresholds, 85% of your benefits will be taxed.
Impact of Other Deductions and Credits
Although it seems simple enough, the reality is that everyone’s tax situation is different and can be complicated, as there are deductions and credits that can influence the overall taxability of your Social Security benefits. For example, medical expenses can make it so that, if they that exceed a certain percentage of your AGI, a special deduction applies, lowering your taxable income.
Qualified charitable contributions can also help you lower your tax bill, especially when it comes to tax advantaged retirement accounts which can significantly up your income. The best thing you can do is to figure out all your tax exemptions and credits so that you can get a clearer picture of what you owe before panicking.
Exceptions and Special Cases
As we have stated everyone is different and so are their needs and the federal government recognizes that when it comes to taxing benefits. There are a myriad of exemptions that apply to those who receive benefits due to a disability. In those cases even if you surpass the thresholds you may not be taxed (or at least not as harshly) in order to help better cover medical expenses.
In addition to that, there are some types of non-taxable income or specific circumstances such as receiving lump-sum benefit payments, that may be subject to different taxation rules and would need to be assessed separately. In case of doubt, consult with an IRS representative or a tax advisor to avoid any mistakes.
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