Taxation of Social Security Benefits

Many people are not familiar with the tax liability associated with Social Security payments, and the income generated from Social Security may be taxed at 0%, 50% or more depending on other factors. We call this the “Tax Torpedo” effect because, depending on your total income and marital status, as much at 85% of your Social Security benefit may be taxable. However, the impact can be minimized with careful planning.

Generally speaking, if Social Security is your only income, your benefits will not be taxable. But if you have other income being generated from assets such as a pension or other savings vehicles, you could owe taxes on at least a portion of the government provided benefits.

You can estimate your tax liability by adding up all of your annual income sources other than Social Security. For most people, this is the sum of wages, taxable interest, realized capital gains, and other income, and it is called your “Modified Adjusted Gross Income” or MAGI.  To your MAGI, add one-half of your Social Security income. If this amount (known as your “Provisional Income”) is greater than the base amounts in the table below, you will owe taxes on a portion of your benefits.

  • $25,000 for single, heads of household, or qualifying widow/widower with a dependent child.
  • $25,000 for married individuals filing separately and who did not live with their spouses at any time during the tax year.
  • $32,000 for married couples filing jointly.
  • $0 for married individuals filing separately who lived together at any time during the tax year.

If your income exceeds the base amount for your filing status, your Social Security benefits are taxable. For some filers, the taxable portion can be as much as 85%. Take a look at the case study in this newsletter to see how one couple was impacted by taxes on their Social Security benefit. For some couples, the Tax Torpedo can effectively lower Social Security benefits by almost 30%!

Let’s look at an example: Bill and Sue are married, filing jointly. They have a Modified Adjusted Gross Income of $46,000, and they receive annual Social Security payments of $18,000. Their Provisional Income is $55,000 ($46,000 + 1/2 of $18,000). The base amount for determining tax liability from the table above is $32,000. The taxable portion of the Social Security benefits is the lowest of three amounts:

  • The sum of 50% of Provisional Income between $32,000 and $44,000, plus 85% of Provisional Income above $44,000. For Bill and Sue, this amount is $15,350:
  • (($44,000 – $32,000) x 1/2) + (($55,000 – $44,000) x 85%) = $15,350
  • 85% of Social Security benefits. For Bill and Sue, this amount is $15,300+
  • $18,000 x 85% = $15,300
  • The sum of one half of the Social Security benefits plus 85% of Provisional Income above $44,000. For Bill and Sue, this amount is $18,350:
  • (1/2 x $18,000) + (85% x ($55,000 – $44,000)) = $18,350

For Bill and Sue, the minimum amount in these three calculations is $15,300, so they must pay taxes on 85% of their Social Security benefits.

The example demonstrates that a couple doesn’t have to be living in luxury before having to pay taxes on 85% of benefits. For someone with a greater income and in the 35% tax bracket during retirement, taxes effectively reduce Social Security benefits by almost 30%.

Our experts on taxes and investing are prepared to guide you through the complexities of managing your Social Security benefit selections. We can advise you about your options and share the most effective tactics in managing your taxes during retirement.

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