You can sign up to take your Social Security retirement benefit as early as age 62. The longer you wait to start it, up to age 70, the higher your monthly check will be. Yet as awesome as it can be to figure out ways to increase your benefit, there is a downside to a larger income. The larger your combined income, the more likely your Social Security benefit will be taxed.
Social Security uses a formula that adds up your adjusted gross income, your non-taxable interest, and half of your Social Security benefit to determine what your combined income is. If that combined income passes a key threshold based on your tax filing status, then up to 50% your Social Security benefit can be taxed . If it passes another threshold, then up to 85% of your Social Security benefit can be taxed.
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What are those thresholds?
If you're single, once your combined income passes $25,000, you reach the 50% threshold, and once it passes $34,000, you reach the 85% threshold . If you're married and file a joint return, the 50% threshold is at $32,000, and the 85% threshold is at $44,000. If you're married and file a separate return, chances are that your Social Security benefit will face taxation at virtually any combined income level.
If those limits seem fairly low, there's a good reason for that. The initial 50% taxation threshold was set in 1983, and was intentionally not indexed to inflation. By not indexing the taxable threshold to inflation, Congress largely assured that the amount of benefits that would be taxed would increase over time as inflation reduced the purchasing power of a dollar.
Those taxes on benefits feed right back into the Social Security system, handing the program around $49 billion in revenue in 2022. It's a small, but important part of keeping Social Security funded.
What can you do about it?
If you expect that you may face taxes on your Social Security benefit in 2024, there may be a few things you can do to help yourself. Recognize, though, that choices you make today may spark different types of consequences in the future.
For instance, if you are withdrawing money from your Traditional-style retirement accounts above your Required Minimum Distribution, if you cut back on those withdrawals, you will reduce your income. In addition to reducing your direct tax burden on the withdrawal related income, by reducing your combined income, you may be able to reduce the tax burden on your Social Security benefit.
The downside of that approach, though, is that it keeps more of your money inside those Traditional-style retirement plans. The percentage of your account balance that you need to withdraw due to those RMDs increases each year. That can ultimately lead to even bigger costs, like seeing your Medicare Part B and D premiums increase, on top of those taxes on your Social Security benefits.
Likewise, if you have control over your taxable investment accounts, you might be able to choose what you sell and what you buy to minimize your capital gains, dividends, and interest income. Keeping those forms of income down will keep down that combined income number that goes into determining how much of your Social Security is taxed.
Of course, even that has trade-offs. In general, it's not a good idea to make investing decisions solely based on the tax impact. That can leave you in a situation where what you end up holding is not the best set of assets for your overall financial picture.
Get started now
Indeed, even if it does result in more near-term taxes on your Social Security benefit, it's important to take a bigger picture approach to your overall finances. With this still being January, you've got time to assess your overall situation for 2024 and make decisions that can make the most sense for you as you consider your entire retirement.
So make today the day you put your plan in place on how you will handle your Social Security benefit and the taxes it may face. The choices you make now just might help you get in a better spot in 2024 and beyond.
