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March 31, 2022
As you prepare for retirement, it’s essential to understand what your taxes will be. You may think your Social Security benefits are tax-free. After all, why would the government pay you money with one hand and take it back with the other? But the truth is, you may pay taxes on your Social Security benefits if you have other sources of income in retirement.
At a certain level of overall income – that includes your Social Security benefits, paid work, withdrawals from investments, passive income or other sources – your Social Security benefits are taxed. And, if you work before full retirement age, your benefits are reduced.
There are three ways your Social Security could be reduced:
Continue reading for more detail.
Once you hit a certain age, the rules for Social Security taxes are similar to other federal income taxes in that the more money you make overall, the more you are taxed.
But even at the highest tax rate, at least 15 percent of your Social Security benefits are shielded from tax.
The IRS has a rule of thumb for savers who want to see if their social security benefits are taxable: add one-half of your Social Security benefits to all your other income, including tax-exempt interest.
Lowest Bracket: If the number is greater than $25,000 for single filers or $32,000 for married couples, you will owe tax on your benefits.
Middle Bracket: If you exceed the threshold for tax-exempt benefits, but your combined income for single filers is below $34,000, you pay tax on half of your benefits. Fifty percent of your benefits are taxable If you are married and filing jointly, and you make between the minimum amount but less than $44,000 in combined income.
Highest Bracket: Single people making more than $34,000 and married couples making more than $44,000 combined income have 85 percent of their benefits taxed. But remember, that doesn’t mean the government takes 85 percent of your benefit!
Fifteen percent of the benefit for high earners is tax-free, and the part that is taxable is only taxed at your income tax bracket, for example, 24 percent for married couples making between $168,401 and $321,450.
The rules given above for taxing Social Security benefits only apply to Federal taxes.
Thirteen states also tax Social Security benefits.
Thirty-seven states do not tax Social Security benefits.
Minnesota, North Dakota, Vermont and West Virginia apply state taxes to Social Security benefits using the same brackets as the federal government.
These states each have their own taxation rules for Social Security: Colorado, Connecticut, Kansas, Missouri, Montana, Nebraska, New Mexico, Rhode Island and Utah.
These 37 states do not tax Social Security retirement income: Alabama, Alaska, Arizona, Arkansas, California, Delaware, District of Columbia, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, Nevada, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Virginia, Washington, Wisconsin and Wyoming.
State and federal taxes are not all you need to worry about with Social Security. There can also be a temporary reduction in benefits if you have not achieved full retirement age and you are receiving work income above a certain level.
So while you are allowed to start benefits as soon as you turn 62 , the sooner you start collecting your benefits, the less your monthly benefit will be. Conversely, the longer you wait (up to 70 years old), the more your monthly income will be.
And the other downside to starting benefits early is that if you elect to collect benefits before your full retirement age and you are receiving work income, you will get less money than if you wait to collect, and the money you get will be subject to tax.
The full retirement age from 2022 onward is 67 for anyone born after 1960.
For work before full retirement age, Social Security will deduct money from your benefits according to the following guidelines:
However, you will get the lost benefits back because your Social Security payments will be increased when you reach your full retirement age. (This is to take into account those months in which benefits were withheld.)
And, after you reach full retirement age, you will no longer pay a work penalty. The month you reach full retirement age, you receive your full benefit whether you work or not. (However, as stated above, up to 85% of your benefits may be taxed by the Federal government and state governments if you earn more than the limits.)
Summary: To put it simply, if you work before full retirement, your monthly benefit is cut by a dollar for every two dollars you make above the $19,560 limit. For example, if your monthly benefit is $800 ($9,600 per year), and you earn $29,560 ($10,000 over the $19,560 limit) from work, your benefit will be cut by $5,000 to $4,600 for the year.
But that also means that your potential tax burden is less.
If you work after full retirement age, you will receive your full benefit no matter what, but depending on how much money you make, up to 85% of your Social Security benefits will be taxable at whatever your marginal tax rate is.
Taxes are a significant cost and can eat away at your retirement savings and income potential. Tax planning should be a critical component of creating a reliable retirement plan.
One of the easiest ways to reduce tax expenditures is to (legally) reduce your annual income levels to stay in the lowest possible tax bracket. Remember, the less you earn, the less you are likely to pay in taxes.
The NewRetirement Planner makes it easy to create a tax forecast for the rest of your life. The system automatically calculates your :
To create these forecasts, the NewRetirement Planner gives you robust inputs to create the most reliable projections possible. You can:
The NewRetirement Planner is the easiest way to plan retirement taxes.
Want more retirement planning tax tips? Try Retirement Planning and Your Taxes: Tips for Keeping More of Your Own Money
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Your benefits are determined by your Full Retirement Age (FRA), your benefit amount and FRA and the age when you decide to start benefits.
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