Is Social Security Taxable?

Is Social Security taxable? For most Americans, it is. That is, a majority of those who receive Social Security benefits pay income tax on up to half or even 85% of that money because their combined income from Social Security and other sources pushes them above the very low thresholds for taxes to kick in.

But there are three strategies you can use—place some retirement income in Roth IRAs, withdraw taxable income before retiring, or purchase an annuity, to limit the amount of tax you pay on Social Security benefits.

How Much of Your Social Security Income Is Taxable?

Social Security payments have been subject to taxation above certain income limits since 1983. No inflation adjustments have been made to those limits since then, so most people who receive Social Security benefits and have other sources of income pay some taxes on the benefits.

However, regardless of income, no taxpayer has all their Social Security benefits taxed. The top level is 85% of the total benefit. Here’s how the Internal Revenue Service (IRS) calculates how much is taxable:

• The calculation begins with your adjusted gross income (AGI) from Social Security and all other sources. That may include wages, self-employed earnings, interest, dividends, required minimum distributions (RMDs) from qualified retirement accounts, and other taxable income.
• Tax-exempt interest is then added. (It isn’t taxed, but it goes into the calculation.)
• If that total exceeds the minimum taxable levels, then at least half of your Social Security benefits will be considered taxable income. You must then take the standard or itemize deductions to arrive at your net income. The amount you owe depends on precisely where that number lands in the federal income tax tables.

Combined Income = Adjusted Gross Income + Nontaxable Interest + Half of Your Social Security Benefits

Individual Tax Rates

Benefits will be subject to tax if you file a federal tax return as an individual and your combined gross income from all sources is as follows:

• From $25,000 to $34,000: You may have to pay income tax on up to 50% of your benefits.
• More than $34,000: Up to 85% of your benefits may be taxable.

The IRS has a worksheet that can be used to calculate your total income taxes due if you receive Social Security benefits. When you complete this exercise in arithmetic, you will find that your taxable income has increased by up to 50% of the amount you received from Social Security if your gross income exceeds $25,000 for an individual or $32,000 for a couple. The taxed percentage rises to 85% of your Social Security payment if your combined income exceeds $34,000 for an individual or $44,000 for a couple.

For example, say you were an individual taxpayer who received the average amount of Social Security: about $18,000. You also had $20,000 in “other” income. Add the two together, and you have a gross income of about $38,000. However, your combined income is computed as only $29,000 (other income plus half of your Social Security benefits). That’s within the $25,000–$34,000 range for a tax of 50% of your benefits So, half of the difference between that income and the $25k threshold is your taxable amount: ($28,000 – 25,000 = $3,000; $3,000/2 = $1,500). The calculation can become more complicated for taxpayers with different forms of income.

Married Tax Rates

For couples who file a joint return, your benefits will be taxable if you and your spouse have a combined income as follows:

• From $32,000 to $44,000: You may have to pay income tax on up to 50% of your benefits.
• More than $44,000: Up to 85% of your benefits may be taxable.

For example, say you are a semi-retired couple filing jointly and have a combined Social Security benefit of $26,000. You also had $30,000 in combined “other” income. Add the two together, and you have a gross income of $56,000. Your combined income for Social Security is $43,000 (other income plus half of your Social Security benefits). This combined income falls in the $32,000–$44,000 range, meaning that half the difference between the income and the threshold is computed at 50% to get your amount taxable: ($43,000-32,000 = $11,000; $11,000/2 = $5,500).

Social Security Benefits Tax Tool

This being the IRS, the straightforward example above may not apply to you. The IRS’s Interactive Tax Assistant (ITA) will lead you through the possible complications and calculate what part of your income is taxable. IRS Notice 703 describes the tax rules for benefits.

Are Spousal, Survivor, Disability, and SSI Benefits Taxable?

These programs follow the same general rules as the Social Security program for retirees, except for Supplemental Security Income (SSI).

Spousal Benefits

If you don’t have Social Security benefits but collect spousal Social Security benefits based on your marital partner’s benefits, the rules are the same as for all other Social Security recipients. If your income is above $25,000, then you will owe taxes on up to 50% of the benefit amount. The percentage rises to 85% if your income is above $34,000.

Survivor Benefits

Survivor benefits paid to children are rarely taxed because few children have other income that reaches the taxable ranges. The parents or guardians who receive the benefits on behalf of the children do not have to report them as part of their income.

Disability Benefits

Social Security disability benefits follow the same rules on taxation as the Social Security retiree program. Benefits are taxable if the recipient’s gross income is above a certain level. The current threshold is $25,000 for an individual and $32,000 for a couple filing jointly.

SSI Benefits

SSI is not Social Security; it’s a needs-based program for people who are blind, disabled, or age 65 and older. SSI benefits are not taxable.

Paying Taxes on Social Security

You should get a Social Security Benefit Statement (Form SSA-1099) each January detailing your benefits during the previous tax year. You can use it to determine whether you owe federal income tax on your benefits. The information is available online if you enroll on the Social Security website.

If you owe taxes on your Social Security benefits, you can make quarterly estimated tax payments to the IRS or have federal taxes withheld from your payouts before you receive them.

State Taxes on Social Security

Twelve states tax Social Security benefits in some cases. Check with your state tax agency if you live in one of these states—Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, or West Virginia. As with the federal tax, how these agencies tax Social Security varies by income and other criteria.

3 Ways to Avoid Taxes on Benefits

The simplest way to keep your Social Security benefits free from income tax is to keep your total combined income below the thresholds to pay tax. However, this may not be a realistic goal for everyone, so there are three ways to limit the taxes that you owe.

• Place retirement income in Roth IRAs
• Withdraw taxable income before retiring
• Purchase an annuity

Place Some Retirement Income in Roth Accounts

Contributions to a Roth IRA or Roth 401(k) are made with after-tax dollars. This means they’re not subject to taxation when the funds are withdrawn. Thus, the distributions from your Roth IRA are tax-free, provided that they’re taken after you turn 59½ and have had the account for five or more years. As a result, the Roth payout won’t affect your taxable income calculation and won’t increase the tax you owe on your Social Security benefits. Distributions taken from a traditional IRA or traditional 401(k) plan, on the other hand, are taxable.

The Roth advantage makes it wise to consider a mix of regular and Roth retirement accounts well before retirement age. The blend will give you greater flexibility to manage the withdrawals from each account and minimize the taxes you owe on your Social Security benefits. A similar effect can be achieved by managing your withdrawals from conventional savings, money market accounts, or tax-sheltered accounts.

Withdraw Taxable Income Before Retirement

Another way to minimize your taxable income when drawing Social Security is to maximize, or at least increase, your taxable income in the years before you begin to receive benefits.

This means you could withdraw funds a little early—or “take distributions,” in tax jargon—from your tax-sheltered retirement accounts, such as IRAs and 401(k)s. You can make penalty-free distributions after age 59½. This means you avoid being dinged for making these withdrawals too early, but you must still pay income tax on the amount you withdraw.

Since the withdrawals are taxable (unless they’re from a Roth account), they must be planned carefully with an eye on the other taxes you will pay that year. The goal is to pay less tax by making more withdrawals during this pre–Social Security period than you would after you begin to draw benefits. That requires considering the total tax bite from withdrawals, Social Security benefits, and other sources. Be mindful, too, that at age 72, you’re required to take RMDs from these accounts, so you need to plan for those mandatory withdrawals.

This strategy has another benefit: By using these distributions to boost your income when you’re retired or nearing retirement, you might be able to delay applying for Social Security benefits, which will increase the size of the payments.

Purchase an Annuity

A qualified longevity annuity contract (QLAC) is a deferred annuity funded with an investment from a qualified retirement plan or an IRA. QLACs provide monthly payments for life and are shielded from stock market downturns. As long as the annuity complies with IRS requirements, it is exempt from the RMD rules until payouts begin after the specified annuity starting date.

By limiting distributions—and thus taxable income—during retirement, QLACs can help minimize the tax bite taken from your Social Security benefits. Under the current rules, an individual can spend 25% or $135,000 (whichever is less) of a retirement savings account or an IRA to buy a QLAC with a single premium. The longer an individual lives, the longer the QLAC pays out.

QLAC income can be deferred until age 85. A spouse or someone else can be a joint annuitant, meaning that both named individuals are covered regardless of how long they live.

Remember that a QLAC shouldn’t be bought only to minimize taxes on Social Security benefits. Retirement annuities have advantages and disadvantages that should be weighed carefully, preferably with help from a retirement advisor.

The Bottom Line

Most advice on Social Security benefits focuses on when you should start taking benefits. The short answer is to wait until you’re age 70 to maximize the amount that you get. Still, another consideration is how to prevent your Social Security benefits from taking a big tax bite out of your overall retirement income. The answer is to plan well in advance to minimize your overall tax burden during your retirement years.