Many Americans work throughout their lives, paying Social Security taxes to help fund the key retirement benefits program. Most of them figure that the taxes they pay toward those benefits should entitle them to their benefits without any further tax. Yet the IRS does impose income tax on Social Security benefits in some circumstances, and it's important to incorporate those taxes into your decision-making process about when to claim your Social Security.
Who has to pay income taxes on their Social Security?
Social Security benefits haven't always been taxable. Until the early 1980s, the IRS didn't collect income tax on anyone's benefits, but reform efforts at that time that were aimed at trying to ensure the long-term financial stability of the Social Security program included provisions that imposed some income tax liability on some taxpayers' benefits to increase overall program revenue.
The key to whether you have to pay income tax on any of your Social Security benefits is your modified income. In order to come up with that number, you first need to take any outside income you have other than Social Security benefits, including work income; interest, dividends, and taxable gains from investments; municipal bond interest; and other income sources such as taxable pensions or rental income. Once you've added those numbers up, you then divide your total Social Security benefits for the year by two and then add the result to the total from other income sources.
The final number you get determines whether or not you'll have to deal with including some of your benefits as taxable income. The table below shows the threshold numbers for various maximum amounts of Social Security income taxation:
If Your Filing Status Is...
Then You Could Pay Tax on Up to 50% of Your Social Security if You're Above This Threshold...
And You Could Pay Tax on Up to 85% of Your Social Security if You're Above This Threshold...
Single, Head of Household, Qualifying Widow(er)
Married Filing Jointly
How much in Social Security benefits will get taxed?
An example can help clarify exactly how this situation plays out. Say that a single retiree gets Social Security benefits of $1,250 per month, withdraws $1,000 each month from a traditional IRA, and gets another $1,000 monthly from regular taxable investments. In that case, the total outside income would be $24,000 for the year. Add in $7,500, or half of the $15,000 total that the person gets from Social Security, and the final result is $31,500. As you can see above, that figure is between $25,000 and $34,000, and that means that the maximum amount of Social Security benefits that could be subject to tax is 50% of the $15,000 total, or $7,500. If the total were above $34,000, then up to 85% of benefits could get included as taxable income.
However, the table above only sets the maximum amounts to be included in tax. In most cases, the portion of your Social Security benefit that actually gets taxed will be smaller than the 50% or 85% maximum. In the example you just saw, for instance, only $3,250 of the person's Social Security benefits would be subject to tax. That works out to between 20% and 25% of the total benefits the taxpayer received during the year.
Fortunately, there are calculators to help you figure out exactly how much of your benefits will get taxed. This Social Security income tax calculator lets you enter all your income from Social Security and other sources and then runs you through the IRS worksheet for determining how much is taxable.
Be smart about Social Security
As you can see, your outside income has an impact on whether you'll pay tax on your Social Security benefits. In some cases, that makes it smart to delay taking Social Security until your income from other sources goes down. Regardless of your final decision, however, knowing that you might have to pay some income tax on your retirement benefits will help you plan better and avoid an unpleasant surprise.