Many people pay federal income tax on Social Security benefits. How much of your Social Security is taxed depends on how much income you have from other sources in addition to your benefits.
One way to tell if you might have a tax bill is to add half your annual benefits to your other income for the year. If the total is over $25,000 for singles or $32,000 for married couples, you could pay tax on at least some of your benefits.
The taxes are based on your “combined income,” which includes:
- Your adjusted gross income. That includes earnings, investment income and retirement plan withdrawals.
- Any tax-exempt interest, such as interest on municipal bonds.
- Half of your Social Security benefit.
Here’s how it works if you’re single:
|If your combined income is:||Then you owe tax on:|
|Up to $25,000||None of your benefit|
|$25,000 to $34,000||Up to 50% of your benefit|
|Over $34,000||Up to 85% of your benefit|
Here’s how it works if you’re married:
|If your combined income is:||Then you owe tax on:|
|Up to $32,000||None of your benefit|
|$32,000 to $44,000||Up to 50% of your benefit|
|Over $44,000||Up to 85% of your benefit|
If your benefits are taxable, it doesn’t mean that you will lose 50% to 85% of your checks. Instead, that’s the portion on which you’ll pay taxes at your regular income tax rate. (Federal income tax rates currently range from 10% to 37%.)
The IRS has a worksheet to help you figure your tax, or you can use tax software.
Most states don’t tax Social Security, but a few do, including Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia. (West Virginia is phasing out state taxation of Social Security, and as of the 2021 tax year it will no longer tax benefits for most residents.) Typically, these states exempt certain amounts and tax the rest.
Beware the tax torpedo
The odd way Social Security benefits are taxed can cause something called the “tax torpedo,” which is a sharp rise and then drop in marginal tax rates. (A marginal tax rate is basically how much additional tax you pay on an additional dollar of income.)
Middle-income retirees who would otherwise be in the 12% federal tax bracket, for example, could find themselves paying a marginal tax rate of 22% on a large portion of their income, while those in the 22% bracket could see a marginal tax rate of 40.7%, according to researchers William Reichenstein, a professor at Baylor University, and William Meyer, CEO of Social Security Solutions Inc., who presented their findings in the July 2018 Journal of Financial Planning.
Here’s why: You can have a certain amount of other income, such as earnings or IRA withdrawals, in addition to your Social Security benefit without paying higher marginal tax rates. Once your other income rises above certain levels, though, taxes are triggered on 50% of your benefit. Add even more other income, and now you’re paying tax on 85% of your benefit. Those additional taxes boost your marginal tax rate.
Once your income exceeds a certain level, you’ve paid all the taxes on your benefit you could possibly pay, and your marginal tax rate settles back down to equal your federal tax bracket.
Here’s an example the researchers calculated showing how additional income can affect the marginal tax rate of a single person with $30,000 in Social Security benefits, based on 2018 tax rates:
|Other income||Federal tax bracket||Marginal tax rate|
|$0 to $12,400||0%||0%|
|$12,401 to $18,750||10%||15%|
|$18,751 to $19,000||12%||18%|
|$19,001 to $34,568||12%||22.2%|
|$34,569 to $43,706||22%||40.7%|
|$43,707 to $70,600||22%||22%|
|$70,601 to $145,600||24%||24%|
The tax torpedo can affect single people with other income that ranges from $10,733 to $48,706, depending on how much Social Security they get, and married couples with other income between $17,538 to $66,941. For example, for a couple receiving $20,000 in Social Security benefits, the tax torpedo inflates marginal tax rates when their other income is between $25,067 and $46,941, the researchers found.
How delaying benefits could trim your taxes
Middle-income people can reduce the tax torpedo’s effect by delaying the start of Social Security benefits until age 70 and taking income instead from retirement accounts or other savings, the researchers found. The larger benefit at age 70 means people can draw less from their other accounts, resulting in a lower tax bill.
The researchers give an example where a married couple wants to spend $75,000 in retirement. They could start Social Security benefits at age 62 and collect $31,860 annually, withdrawing $48,322 from their retirement accounts. This approach would generate a $5,002 tax bill on about $80,182 of income. Nearly $14,000 of their retirement plan withdrawal would be subject to 22% marginal tax rate.
Alternately, they could delay applying for Social Security and their future checks could grow about 7% to 8% each year until age 70, when benefits max out. At that point, the couple’s benefit could equal $52,416 and they would need to withdraw just $23,327 from their retirement funds. Now, only $4,017 of their retirement plan withdrawal is subject to their highest marginal tax rate of 18.5%, and their total federal tax bill is just $743. Delaying benefits until 70 allowed them to reduce combined income by about $14,600, decreasing the taxable portion of Social Security benefits by about $12,400.
How delaying Social Security can decrease your tax bill
(Target income: $75,000)
|Income source||Begin benefits at 62||Begin benefits at 70|
|Retirement funds (or other income)||$48,322||$23,327|
Taking withdrawals from tax-deferred accounts early in retirement also can reduce the required minimum distributions (RMDs) that are required starting at age 72. (The passing of the Setting Every Community Up for Retirement Enhancement Act, or SECURE Act, in late December 2019 moved the timing of initial RMDs to age 72 from 70 ½.)
The tax torpedo also affects higher-income people, but there’s not much they can do about it once 85% of their benefits are subject to taxation. Instead of worrying about the torpedo, their focus instead should be strategies to reduce the income that determines premiums for Medicare Part B and Part D, the researchers found.
Juggling all this is complicated enough that it can pay to consult a tax pro before you start Social Security or withdrawals from retirement funds. Check in again before age 72, when required minimum distributions begin.