If you’re planning for Social Security to fund even part of your retirement, you should be aware that at least a portion of your benefits may be taxable. In other words, you shouldn’t count on receiving the full amount of your projected benefit in your checking account, even if anticipated cuts to Social Security don’t materialize. However, this isn’t a particularly draconian provision, as distributions from most retirement plans, like traditional IRAs and 401(k) plans, are also usually taxable. As with any financial planning, the best course of action is always to have the facts in front of you as early as possible so you can make prudent decisions. With that in mind, here are things that every American should know about Social Security and taxes.
Benefits Are Never Fully Taxable
While it would be nice if Social Security benefits were never taxable, the good news is that they are never 100% taxable. In fact, only about 56% of recipients through 2050 are expected by the Social Security Administration to pay any taxes at all on their benefits. Of those people being taxed, they will pay taxes on either 50% or 85% of their payouts — but never 100%.
Your Income Determines the Taxability of Your Benefits
Whether or not your benefits are taxable is not a random decision by the Social Security Administration. In fact, recipients actually have some degree of control over whether or not they’ll have to pay tax on their benefits. This is because your income determines the taxability of your benefits. If you earn under $25,000 as an individual or $32,000 as a joint filer, you won’t owe any tax on your Social Security. However, if you earn more, you’ll pay tax on either 50% or 85% of your benefits, according to the following breakdown:
- Single filers earning between $25,000 and $34,000: up to 50% of benefits may be taxable
- Single filers earning over $34,000: up to 85% of benefits may be taxable
- Joint filers earning between $32,000 and $44,000: up to 50% of benefits may be taxable
- Joint filers earning over $44,000: up to 85% of benefits may be taxable
While you probably shouldn’t forgo earning outside income simply to avoid taxation of your Social Security benefits, knowing where the brackets lie may allow you to manage your income to your advantage. For example, if you’re single and you’ve earned $24,000 for the year, you may want to try to defer any additional income until the next year, if possible, to avoid making a portion of your benefits taxable.
The Same Tax Treatment Applies to Your Disability Benefits
Social Security is often thought of as a retirement benefits program, and indeed the bulk of the money paid out of the program does go to retirees. But Social Security also paid nearly $11 billion in benefits to disabled workers and their dependents in 2021. For purposes of taxation, Social Security retirement and disability payments are one and the same. In other words, your disability benefits may or may not be taxable, based on your income.
Some States Also Tax Social Security Benefits
In addition to federal tax, you may also face state taxes on your Social Security benefits. As tax policies vary from state to state, it definitely pays to take the time to research where your state lands when it comes to Social Security taxation. According to the Tax Foundation, as of tax year 2021, 37 states and the District of Columbia either had no state taxes at all or excluded Social Security benefits from their calculations of taxable income. Several other states reduce their taxation of benefits based on age or income.
You Can Have Your Taxes Withheld From Your Paycheck or You Can Pay Them Quarterly
Just like your wages or salary, you can elect to either withhold Social Security taxes from your paycheck or pay them yourself quarterly. If you don’t pay your taxes until you file your tax return, you’ll likely owe an underpayment penalty.
The Bottom Line
Although the IRS clearly spells out its policy on Social Security taxation, the details can get complicated, especially for first-time filers. To avoid any issues, you may want to work with a tax or financial advisor to make sure you understand both how much tax you owe and also if there are any steps you can take to minimize your taxation.
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