Please ensure Javascript is enabled for purposes of website accessibility

Why More Retirees May Need to Pay Taxes on Social Security Benefits in the Future

By Katie Brockman – Jun 22, 2020 at 10:06AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

You may be hit with a larger tax bill, even if your income stays the same.

Social Security benefits are a significant source of income for many retirees. Especially if your nest egg isn't as robust as you'd hoped it would be, those monthly Social Security checks can go a long way in helping you enjoy a more comfortable retirement.

However, there's a chance that once you retire, you may not collect as much in benefits as you think. That's partly because the Social Security program is facing a cash shortage and benefits cuts could be looming on the horizon. But your benefits could also be reduced thanks to taxes, and there's a greater chance Uncle Sam will take a cut of your monthly checks in the future.

Social Security card with bills and coins

Image source: Getty Images.

How Social Security benefits are taxed

Social Security benefits are subject to both state and federal income taxes. Your state taxes depend on where you live, and you could also owe federal taxes if you earn more than a certain limit, which is called your "combined income."

Your combined income includes half your annual Social Security benefit amount plus all other sources of retirement income (excluding Roth IRA withdrawals). So, for example, if you're collecting $20,000 per year from Social Security and are withdrawing $30,000 per year from your 401(k), your combined income is $10,000 plus $30,000, or $40,000 per year.

Whether you'll owe federal income taxes on your benefits (as well as the percentage of your benefits you'll pay taxes on) depends on your combined income:

Percentage of Your Benefits That Are Taxed Annual Combined Income (Individuals) Annual Combined Income (Married Couples Filing Jointly)
0% Less than $25,000 Less than $32,000
Up to 50% $25,000 to $34,000 $32,000 to $44,000
Up to 85% More than $34,000 More than $44,000

Source: Social Security Administration. 

The good news is that no matter how much you earn, you won't pay taxes on more than 85% of your benefit amount. But to get out of paying federal taxes on your benefits altogether, you'll have to have a combined income of less than $25,000 (or $32,000) per year, which is barely enough for many retirees to survive.

Why more retirees will owe taxes in the future

The combined income limit was established in 1984, when Social Security benefits first became taxable. At that point, only 10% of retirees surpassed the income limit and were required to pay federal income taxes on their benefits, according to a report from the Senior Citizens League.

However, although Social Security benefits are adjusted each year to account for cost-of-living changes, the annual income limit has never been adjusted for inflation. In other words, retirees are seeing their benefits gradually increase due to inflation, but the income limit is staying the same. That, in turn, means more retirees will be subject to income taxes on their benefits.

While only 10% of retirees paid taxes on a portion of their benefits in 1984, that percentage has jumped to 50% in 2019, the Senior Citizens League found. As the general cost of living continues to increase, even more retirees could face taxes on their benefits in the future if the income limit is not adjusted.

What does this mean for future retirees?

It means there's a good chance you'll need to pay income taxes on your benefits, and it's wise to start preparing now. Even if right now your combined income is under the income limit, that could change as your benefits gradually increase after several years of annual cost-of-living adjustments.

As you're planning for retirement, be sure to consider how taxes will affect your benefits -- especially if you expect Social Security to make up a good chunk of your retirement income. A little preparation can go a long way, and by planning for taxes now, they're less likely to take you by surprise in retirement.

The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
332%
 
S&P 500 Returns
104%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/30/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.