When you retire, the way you file your taxes will change. Especially if you are claiming Social Security benefits. It’s important to understand how your taxes will be affected by Social Security benefits before claiming. Continue reading for what you need to know about taxes and Social Security benefits.
A majority of retirees who receive Social Security benefits are required to pay income taxes on half up to 85% of the money they received due to their Social Security income and other income sources surpassing the tax thresholds.
The IRS rules of taxation on Social Security benefits are:
If you are a single filer with a combined income:
- Between $25,000 and $34,000, you will need to pay taxes on up to 50% of your benefits.
- Over $34,000, you will need to pay taxes on up to 85% of your benefits.
If you are a joint filer with a combined income:
- Between $32,000 and $44,000, you will need to pay taxes on up to 50% of your benefits.
- Over $44,000, you will need to pay taxes on up to 85% of your benefits.
To find your combined income, you will need to use the following equation:
Your adjusted gross income
+ Nontaxable interest
+ Half of your Social Security benefits
= Your combined income
If you are having trouble calculating this, the IRS has an online tool to determine if your Social Security benefits are taxable here.
How Do I Know How Much I Received In Social Security Benefits?
Each January, you will receive a Social Security Benefit Statement, also known as a Form SSA-1099, that outlines the benefits you received in the previous tax year. This is the best form to use as the basis for calculating your Social Security benefit tax liability.
If you do owe taxes on Social Security benefits, you can have federal taxes withheld from your benefits checks or make quarterly payments to prevent receiving a large tax bill in tax season.
Tax Strategies To Lower Your Social Security Benefits Tax Liability
With the income thresholds for Social Security benefit taxation being quite low, it’s great to have tax strategies to avoid taxes on benefits.
1. Utilize Roth Accounts For Your Retirement Income
Since contributions to Roth IRAs and Roth 401(k)s are made with after-tax dollars, withdrawals are not subjected to taxation. However, you do have to wait until you are at least 59 ½ years old and have had the account for five years or more. These Roth withdrawals will not be included in your taxable income calculation and will not increase the taxes you owe on Social Security benefits.
2. Withdraw Taxable Income Prior To Retirement
Another strategy to lower your taxable income when claiming Social Security benefits is to increase your taxable income prior to receiving benefits. One example of this is taking distributions from tax-sheltered retirement accounts, including IRAs and 401(k)s once you are 59 ½ years old to receive a penalty-free distribution. You will have to pay taxes on these disbursements from non-Roth accounts, so they need to be planned out carefully. The goal of this strategy is to pay less in taxes prior to claiming Social Security by taking on more withdrawals from the non-Roth accounts.
Another benefit of this strategy is possibly being able to delay claiming Social Security benefits by taking these distributions to boost your retirement income. By delaying claiming Social Security benefits, your payment amount will be higher.
3. Roth Conversions
Roth conversions are a great way to shelter your retirement income from taxes. A Roth conversion is the transfer of retirement assets from 401(k)s, SEP, SIMPLE IRA, or Traditional IRAs to a Roth IRA. With this transfer, the owner will have to pay income taxes on the money that is being transferred into a Roth account, you will then be eligible to make tax-free withdrawals in retirement. You will want to do this prior to claiming Social Security since, in the year of the conversion, the amount transferred will be a part of your taxable income. This could cause your Social Security benefits to be taxed or increase the taxes on your benefit.
Taxes in retirement can be daunting. To guide you through the process, contact me for help at (402) 454-7204 or email me at firstname.lastname@example.org. I will help assist you in navigating the process of financially moving into retirement when it comes to retirement account disbursements, taxes, and Social Security. Schedule a consultation today.