This is one of the most-often asked questions by many people who will soon start receiving Social Security. It has become especially common recently as a growing number of Americans are continuing to work past the age when they can begin receiving Social Security benefits.
Why? Because the answer depends on whether or not you have any earned income other than your Social Security benefits.
How Much is Taxable?
To figure out whether you have to pay federal income tax on your Social Security benefits, you must determine the total amount of your combined income. This is calculated by adding your nontaxable interest and half of your Social Security benefits to your adjusted gross income (or AGI). Here’s the formula:
AGI + nontaxable interest + ½ of Social Security benefits = Combined income
If you’re single and your combined income is between $25,000 and $34,000 a year — or if you’re married and file jointly and your combined income is between $32,000 and $44,000 a year — up to 50 percent of your Social Security benefits will be taxable.
Meanwhile, if you’re single and your combined income is more than $34,000 a year — or if you’re married and file jointly and your combined income is more than $44,000 a year — up to 85 percent of your Social Security benefits will be taxable. No more than 85 percent of Social Security benefits is ever taxable, regardless of the amount of your earned income.
Examples Help Illustrate
Consider John, who is single and has combined income of $30,000 a year. He is eligible to receive $1,500 a month (or $18,000 a year) in Social Security benefits starting at the end of this year. If he chooses to claim these benefits, he will have to pay taxes on half of this amount, or $9,000. Since John is in the 12% tax bracket, he will pay a total of $1,080 a year in federal income tax on these benefits.
Now consider Jane, who is married and has combined income of $50,000 a year. She is eligible to receive $2,000 a month (or $24,000 a year) in Social Security benefits starting at the end of this year. If she chooses to claim these benefits, she will have to pay taxes on 85 percent of this amount, or $20,400. Jane is also in the 12% tax bracket, so she will pay a total of $2,448 a year in federal income tax on these benefits.
States That Tax Social Security
Depending on where you live, you might also have to pay state income tax in addition to federal income tax on your Social Security benefits. The following 13 states assess varying levels of state income tax on Social Security:
- Colorado
- Connecticut
- Kansas
- Minnesota
- Missouri
- Montana
- Nebraska
- New Mexico
- Rhode Island
- North Dakota
- Vermont
- Utah
- West Virginia
Note that West Virginia is phasing out state taxation of Social Security benefits starting in 2021.
If you do have to pay income tax on Social Security benefits, you can do so by making quarterly estimated tax payments or you having the Social Security Administration withhold federal taxes from your benefit payments. You’ll do this by filing IRS Form W-4V and choosing a withholding percentage of 7%, 10%, 12% or 22%. You can’t have a flat dollar amount withheld from benefits to pay federal income tax on Social Security benefits.
How to Minimize Taxes on Benefits
Planning ahead can help you minimize the amount of income tax you must pay on Social Security benefits.
For example, you can try to maximize the amount of taxable income you receive in the years before you start tapping benefits by withdrawing funds from tax-sheltered retirement accounts like, IRAs and 401ks. Also consider making after-tax contributions to a Roth IRA or 401k since distributions from these won’t affect your combined income calculation.
Be sure to talk to your tax advisor and personal financial planner for guidance in your specific situation.
