Receiving Social Security benefits is advantageous in retirement, but like almost every other form of income, these benefits are taxed by the government. To accurately predict your retirement income (and taxes), it’s important to understand how Social Security benefits are taxed.
Here, we explain everything you need to know about Social Security benefit taxation.
How are Social Security Benefits Taxed?
While Social Security benefits are a vital source of income for many retirees, a portion of these benefits may be subjected to federal income taxes. The Internal Revenue Service (IRS) uses a formula—known as the provisional income formula—to determine the taxable amount.1
Provisional Income Formula
An individual’s provisional income is calculated by adding together their adjusted gross income (AGI), their nontaxable interest, and one-half of their Social Security benefits. The resulting amount is compared to specific thresholds to determine the portion of the benefits that will be subject to taxation.
Taxation Thresholds
The thresholds that determine whether Social Security benefits are taxable are as follows:2
- Single filers with a provisional income between $25,000 and $34,000 may have up to 50% of their benefits subject to taxation.
- Single filers with a provisional income exceeding $34,000 may have up to 85% of their benefits subject to taxation.
- Married couples filing jointly with a provisional income between $32,000 and $44,000 may have up to 50% of their benefits subject to taxation.
- Married couples filing jointly with a provisional income exceeding $44,000 may have up to 85% of their benefits subject to taxation.
It’s important to note that these thresholds are not adjusted for inflation, which means that the benefits of more retirees may become subject to taxation over time.
State Taxes on Social Security Benefits
In addition to federal taxes, some states also impose taxes on Social Security benefits. However, the rules and exemptions vary from state to state. Currently, twelve states tax Social Security benefits to some extent, while the remaining states do not impose state taxes on these benefits.3 The states which tax Social Security benefits are Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont and West Virginia.
Strategies to Minimize Social Security Taxes
There are several strategies that you can implement to potentially reduce the taxes on your Social Security benefits. Here are a few:
Diversify Your Retirement Income
Diversify your sources of income during retirement. By relying on a combination of Social Security benefits, retirement savings, and other investments, you may be able to reduce your provisional income and lower your tax liability.
Consider Delaying Benefits
Delaying your Social Security benefits can increase the amount of your monthly payment. This strategy can also help you push back the taxation of your Social Security benefits if you anticipate being in a higher tax bracket in the future.
Create a Withdrawal Strategy
Strategically managing withdrawals from your retirement accounts can help optimize your tax situation. By taking distributions from taxable accounts instead of tax-deferred accounts, you can potentially minimize your provisional income and reduce the taxation of your Social Security benefits.
Understand State Tax Laws
If you live in a state that taxes Social Security benefits, familiarize yourself with the rules and exemptions that are specific to your state. Consulting with a tax professional can provide valuable insights into how to minimize your state tax obligations. You may also want to take the different state tax laws into account when you are deciding where you will live when you retire.
As the famous saying goes, there are only two guarantees in life: death and taxes. Social Security benefits aren’t exempt from taxes, and understanding how your benefits will be taxed will help you form an accurate retirement income planning strategy.
