For most people, Social Security isn’t something that gets much attention on a day-to-day basis. It only appears in our lives when we look at the taxes taken from each paycheck or receive the yearly newsletter from the Social Security Administration (SSA). As you become eligible for Social Security, it’s increasingly important to understand all the ins and outs of the program, and especially how Social Security is taxed.
While calculating taxes on your Social Security benefits might seem daunting, understanding the process can help you make the best use of your retirement funds.
How is Social Security taxed?
Social Security benefits may be subject to federal taxes and taxed at your ordinary tax rate. The SSA estimates that nearly 56% of people pay taxes on their benefits.
Whether your Social Security benefits are taxed depends on your combined income, which is calculated using:
- Adjusted gross income (AGI): This is any taxable income you have besides Social Security, including wages, self-employed funds, dividends, interest, and any required minimum distributions from your retirement accounts. This number can be found on line 11 of your Form 1040 income tax return.
- Nontaxable interest: This is interest earned that is not subject to federal income tax. This includes interest on municipal bonds or some Roth IRA assets, as well as some Series EE or Series I bonds if used for qualified educational expenses.
These two numbers, plus one-half of your Social Security retirement benefits, make up your combined income. The calculation looks like this:
Combined income = Adjusted gross income + Tax-exempt interest + 1/2 of your Social Security benefits
Federal taxes are only applied to either 50% or 85% of your Social Security benefits. No taxpayer pays taxes on more than 85% of their benefits, regardless of their income.
Here’s how the taxation of Social Security benefits works:
- If your combined income is less than $25,000 annually for an individual return or $32,000 for couples filing jointly, your benefits may not be taxable.
- An individual filing a return with a combined income between $25,000 and $34,000 may pay taxes on up to 50% of their Social Security benefits. Couples filing jointly may be taxed on up to 50% of your benefits if your combined income is between $32,000 and $44,000.
- If your annual combined income is over $34,000 for an individual or $44,000 for a couple filing jointly, up to 85% of your benefits may be taxed.
You can calculate your Social Security taxes for last year's federal tax return by using this worksheet provided by the Internal Revenue Service (IRS).
Example of filing as an individual
If your Social Security income was $15,000 and you also received $20,000 in income from various retirement accounts, a pension, or a part-time job, your total income for the year would be $35,000.
Remember that your combined income only includes half of your Social Security benefits, so the number to use in the calculation would be: $20,000 + $7,500 ($15,000/2) = $27,500
A $27,500 combined income falls between the $25,000 to $32,000 income bracket and means that up to 50% of the Social Security benefits could be taxed.
Example for a married couple filing a joint return
If you are a couple whose combined Social Security benefits were $20,000, and you also received $30,000 in other income, your total would be $50,000.
However, your combined income would be $30,000 + $10,000 = $40,000.
Since this is between $32,000 and $44,000, up to 50% of the Social Security benefits will be taxed.
State Social Security taxes
State taxes on Social Security are a little more complicated as most states don’t tax Social Security benefits. Yet, 12 of them do — Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, and West Virginia — and all have different rates and exclusions.
In Colorado, for example, Social Security is taxed at the flat rate of 4.55%, but you can deduct up to $20,000 in retirement income, including Social Security if you’re between the ages of 55 and 64, or $24,000 if you’re 65 or older.
In nearby Kansas, however, Social Security benefits are not taxed unless your AGI is over $75,000 for both individuals or couples filing jointly. Above that threshold, benefits are treated as regular income and may be taxable at rates ranging from 3.1% to 5.7%.
Additionally, eight states don’t have income tax at all. If you live in Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, or Wyoming, you won’t have to pay state taxes on your benefits or other income sources, although the federal tax still applies. Additionally, New Hampshire doesn’t tax wages, but it does tax interest and dividends. It's phasing out the interest and dividend tax in 2027, however.
Check with your state department of revenue or consult a tax professional to determine the rate in your state.
3 ways to lower your Social Security taxes
As you think about how to invest money for your future, it’s important to take taxes into account so that you don’t pay more than you need to. While many retirees will have to pay taxes on their Social Security benefits, consider using the following tips to help you minimize any potential tax bite.
Withdraw retirement funds before you start Social Security
You may want to maximize your Social Security benefits by waiting to receive them until your full retirement age or later. Your benefit will continue to increase until age 70.
If you wait to claim Social Security benefits, consider withdrawing some of your 401(k) or other tax-sheltered individual retirement funds before using non-taxable retirement funds. This can help spread out the tax burden on those accounts over several years and can be a helpful way to avoid taking Social Security payments before your maximum benefit is available at age 70.
Anything you withdraw from a 401(k) or other taxable retirement accounts while also collecting Social Security factors into your adjusted gross income and could potentially raise your tax bill.
You’ll pay less in taxes by strategically drawing down some of your taxable retirement accounts before applying for Social Security. While you’ll still owe income tax on your 401(k) withdrawals, you won't also be paying tax on Social Security at the same time.
This takes some coordination and planning, so be sure to work with a tax professional and retirement advisor to ensure you’re creating the best game plan for you.
Consider a Roth IRA conversion
Also called a backdoor Roth IRA, a Roth conversion converts funds from a traditional, taxable retirement account into a Roth IRA and can help you minimize the amount you pay in Social Security taxes.
Since Roth IRA’s are funded with after-tax money, withdrawals are income-tax-free provided that you’re at least 59 1/2 and have owned the account for more than five years.
Income from a Roth is not included in the Social Security benefit calculations like a traditional IRA or 401(K) because you’ve already paid taxes on the contribution. This lowers your adjusted gross income and reduces your tax bill accordingly.
Converting money from a tax-sheltered account to a Roth may mean paying higher taxes the year the conversion takes place but a lower tax bill over your retirement. Discuss this option with a tax professional to determine what’s best for your situation.
Consider a QLAC
If you’re worried about running out of money in retirement, you might consider a qualified longevity annuity contract (QLAC). These annuity contracts can act as longevity insurance and offer a guaranteed annual source of income for the purchaser and, when the purchaser dies, often their spouse as well.
A QLAC is an annuity purchased using funds specifically from a retirement account, and the purchaser (you) pays the insurance company a lump sum of money from a 401(k) or traditional IRA account upfront. The contribution limit is either 25% of the account balance or $145,000 for the 2022 tax year, whichever is less, per the IRS.
The annuity guarantees a set payment for the rest of your life that you can start taking any time (you’re required to begin taking payments at age 85), and you’ll only pay taxes when you start to receive payments.
Since you can delay receiving payments up to age 85, a QLAC can also be a helpful way to avoid required minimum distributions (RMDs), which you’re required to take from a traditional IRA starting at age 72. You’ll still pay tax on the money received from a QLAC, but delaying the tax burden until you’re older could be a good way to reduce your taxes earlier in retirement.
A QLAC can be a helpful tool but shouldn’t be purchased just to minimize Social Security taxes. Make sure you work with a tax or retirement professional to help you determine if a QLAC is the right retirement planning option for you.
Is Social Security taxed as regular income?
Social Security is taxed as regular income. Your income tax rate will vary depending on the tax bracket you fall into. However, not everyone pays taxes on Social Security benefits, and those who do pay taxes don’t pay it on 100% of their Social Security benefits.
Individuals making up to $34,000 and married couples filing jointly making up to $44,000 per year may pay taxes on up to 50% of their Social Security benefits. If you make more than $34,000 or $44,000, depending on your filing status, you may pay taxes on up to 85% of your Social Security benefits.
What is the Social Security tax rate?
The Social Security tax rate is your ordinary income tax rate. However, you don’t have to pay taxes on all of your Social Security benefits, and you may not have to pay at all, depending on your combined income.
What is the maximum Social Security income that is taxable?
There is no maximum dollar amount for how much Social Security income (SSI) is taxable. Instead, there is a maximum percentage of Social Security income that is taxable. If you make more than $34,000 if you’re a single filer or $44,000 if you’re married filing jointly, you may pay taxes on up to 85% of your Social Security benefits.
Knowing how the taxes on your Social Security benefits are calculated is an excellent first step in understanding what your tax bill will look like throughout your retirement. It can be helpful to keep these factors in mind as you work with a tax professional to create a strategy and think about saving for retirement.
More from FinanceBuzz: