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One of the biggest surprises would-be retirees face when planning their retirement finances is the fact that their Social Security benefits could very well be subject to income tax.
A financial advisor can help you plan for Social Security and potentially minimize your tax bill on your benefits. Connect with a fiduciary advisor today.
One reason for the confusion is that they never saw their parents or grandparents pay taxes on their benefits. However, more and more retirees are likely to pay taxes on their benefits going forward. As of 2022, approximately 48% of Social Security recipients were paying federal income taxes on their benefits – a number that’s expected to rise to around 56% by 2050, according to an analysis published by the Social Security Administration.
How Social Security Benefits Are Taxed
A retiree calculates how much of his Social Security benefits will be taxable.
Due to rule changes first signed into law by President Ronald Reagan and later expanded by President Bill Clinton, Social Security recipients can face taxes on up to 85% of their benefits depending on their other sources of income. The formula for calculating the tax is called “combined income” or “provisional income,” and it’s not exactly simple.
You can calculate your provisional or combined income by adding half of your annual Social Security benefits to your adjusted gross income (AGI), plus any nontaxable interest paid to you. From there, income brackets determine how much your benefits are considered taxable income.
None of your benefits are taxable if your provisional income is:
Less than $25,000 as a single filer
Less than $32,000 as a joint filer
Up to 50% of your benefits are taxable if your provisional income is:
Between $25,000 and $34,000 as a single filer
Between $32,000 and $44,000 as a joint filer
Up to 85% of your benefits are taxable if your provision income is:
More than $34,00 as a single filer
More than $44,000 as a joint filer
For example, say you receive $2,800 per month in Social Security in 2025, meaning you’ll collect $33,600 in total benefits for the year. Now, imagine that you’ll also withdraw $30,000 from an IRA. As a result, your provisional income would be $46,800 ($16,800 + $30,000). As a single tax-filer, you would be taxed on up to 85% of your benefits since your provisional income exceeds the $34,000 threshold. According to this IRS calculator, you’d pay income taxes on $15,380 of your benefits.
Remember, a financial advisor can help you better understand your tax liability in retirement, including how much of your benefits will be taxable and strategies for mitigating these taxes.
How to Minimize Tax on Social Security
There are several strategies you can use to potentially minimize the taxes you end up paying on your Social Security benefits:
Reduce or delay retirement withdrawals: Postponing or reducing withdrawals from an IRA, 401(k) or other tax-deferred account lowers or eliminates your provisional income. One strategy would be to withdraw cash from a Roth IRA or Roth 401(k), which doesn’t count as taxable income.
Manage your RMDs: At age 73 (or 75 for those who turn 74 after Dec. 31, 2032), the IRS requires you to start taking required minimum distributions (RMD) from your IRAs, 401(k)s and other tax-deferred accounts. If you’re still working and have a 401(k) at that workplace, you aren’t required to take RMDs from that account. If you make a qualified charitable distribution (QCD) from an IRA, that amount can help satisfy your RMD but won’t count as taxable income.
Roth conversion: Converting an IRA or 401(k) to a Roth IRA means you’ll pay income tax at the time of conversion but qualified withdrawals in the future can be made tax-free and won’t count toward your combined income. However, you will likely face taxes on your Social Security benefits in the year that you convert any tax-deferred assets. One strategy is to convert just enough money to keep your taxable Social Security benefits to 50% or 0%.
Watch out for the “tax torpedo”: Be aware that when the taxable amount of your benefits is added to your income, it could push you into a higher tax bracket. This impact is known as the Social Security tax torpedo. Remember to consider all of your retirement income sources when it comes to tax planning. A financial advisor can also help you avoid this tax torpedo and other financial pitfalls of retirement.
Bottom Line
How to manage and minimize the taxes you pay on your Social Security benefits and other retirement income can be complicated. Take the time to estimate your retirement taxes before you start collecting pensions, Social Security and taking withdrawals from retirement accounts.
Retirement Planning Tips
It’s important to understand how required minimum distributions (RMDs) work and how they can impact your tax liability in retirement. These mandatory withdrawals from tax-deferred retirement accounts add to your taxable income and potentially push you into a higher tax bracket. Luckily, SmartAsset has an RMD calculator to help you estimate how much your first RMD may be and when it will be due so that you can plan ahead.
Balancing taxes and retirement income is an important element of financial planning in retirement. A knowledgeable financial advisor can help you decide how to structure and coordinate your income plan to potentially minimize taxes. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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