Social Security benefits are largely paid from taxes on current wage earners, though even current retired recipients can pay taxes back into Social Security if their incomes are high enough. Every year, both taxes and benefits are adjusted based on overall wage and inflation changes, respectively, and those changes can result in higher costs for those that pay the bills. Next year will be no different in that respect, and depending on your personal situation, you might find yourself paying more for Social Security in 2017.
People with salaries above $118,500 will see their Social Security taxes go up on everything they get paid, up to $127,200. Retirees whose combined income is above $25,000 if they're single or above $32,000 if they're married may also see their Social Security-related taxes go up in 2017, depending on how their incomes change.
How much more will you pay?
The Social Security tax rate is 12.4% of your wages, up to that maximum level. Half the tax comes directly out of your paycheck, and the other half is paid on your behalf by your employer, unless you're self-employed and are responsible for the entire tax. That's a net tax increase of as much as $1,078.80for every affected wage earner.
If you're a Social Security recipient, figuring out your tax impact for 2017 can be a little tougher. If your Social Security benefits are subject to tax, the tax on your benefits goes to help shore up Social Security , and you get taxed on it based on your federal income tax rate. The first step on figuring out whether you'll pay that tax is to calculate your combined income. To do that, you add together your:
- Adjusted gross income,
- Your (otherwise) nontaxable interest income, and
- Half of your Social Security income.
If you're single and that number is between $25,000 and $34,000, or if you're married and file jointly with that number between $32,000 and $44,000, half your Social Security benefit is subject to tax. If your combined income is above those levels, 85% of your Social Security benefit is subject to tax. If you're married and file a separate return, chances are strong that at least some of your Social Security benefit will be subject to tax.
Those combined-income bands that subject your Social Security benefits to taxation have remained the same since they were created, with no adjustment for inflation or changes in average wage levels. That means that if your income increases, so does your chance of seeing your Social Security taxed as well as the total tax you may owe on those benefits. When taxes were first levied on Social Security recipients, only around 8% of recipients paid the tax. These days, around 49% do.
Many people think of retirement as a time of living on a fixed income, but that's not always the case. Social Security itself pays an inflation adjustment, potentially increasing that benefit annually. In addition, if you've been a diligent saver, once you pass age 70.5, traditional IRA and 401(k) plans are generally subject to mandatory minimum withdrawals that get bigger as a percentage of your balance every year. Both of those sources of income could lift your income to make more of your Social Security taxable.
What can you do about it?
For the most part, Social Security-related taxes are fairly tough to avoid, unless you can control the timing, the nature, and the amount of your income. If you're not one of the few in the position to do that in the near term, your best short-term option might simply be to prepare for the increased taxes you may face by knowing what you can cut back.
Over time, you may be able to find ways to adjust your income to reduce the impact of those taxes, but know that those adjustments frequently come at a cost elsewhere. For instance, if you're a small-business owner able to convert some of your salary income to dividend income, you may be able to save on the Social Security taxes. Note that this likely comes at a cost of a lower Social Security benefit for you down the road and potentially higher corporate-level taxes on your business along the way.
On the flip side, if you're a retiree recipient of Social Security, you may have some control over your investment income. For example, if you convert two years' worth of spending from investments to cash in a year, you may be able to go a tax year without generating capital gains from your portfolio. In that off year, your combined income might be low enough to avoid triggering the tax on your Social Security benefit, but you'll likely end up paying more in the year you do that double conversion.
Balance the costs and benefits to build your best retirement
When all is said and done, the costs of Social Security need to be covered as long as the program remains in existence. Rather than focusing on avoiding paying those costs, your objective should be on maximizing the net benefits you get across your entire retirement plan. The key tools at your disposal are Social Security, any pension you may get, and the money you're able to save between now and retirement.
By balancing the costs and benefits across those tools over the rest of your career, you can design and build a retirement plan that gives you the best chance of having your golden years be financially comfortable. When it comes time to retire, after all, what matters most is what you have available to cover your lifestyle, not how much it cost you to get there along the way.