How To Know If Your Social Security Is Taxable

You’ve worked hard for decades, and now you want to enjoy your golden years.  If planned to have a nice standard of living in retirement, you are likely going to get hit with income taxes. The more retirement income you have, the more taxes you likely pay, just the way it is.  The myth that Social Security is not taxed is just that, a myth.

An estimated 60% of retirees will owe no federal income taxes on their Social Security Benefits. Which is likely where many people come to believe Social Security benefits are tax-free. They are not. This just means that a majority of retirees are living on what could be described as low income.

The good news is that Social Security income is not taxed quite as heavily as other forms of retirement income. Regardless of how much you make in retirement, at least 15% of your Social Security benefits will come to you tax-free.

Can You Live On Social Security Alone?

Surviving on Social Security alone in retirement would be difficult for most. The average person received just $17,040 per year in 2019. The maximum Social Security benefit for 2020 is expected to be $2861 at full retirement age. (More if you wait until 70). For sure this is a good amount of money, don’t get me wrong, but not exactly living rich.

How much of your Social Security benefits will be taxed will ultimately depend on your other income sources. This will be a combination of all other earnings in a given year, plus some portion of your Social Security benefits. These other sources will include everything from distributions from your 401(k) or IRA, wages from work, royalties or rental income.

Most people know to have a strategy to get the largest Social Security Benefits throughout their retirements. Having a plan to pay the least amount of taxes on your Social Security benefits it much less common.

Keep reading to learn more about Social Security taxation.

How is Social Security Taxed?

Let’s get down to the nuts and bolts of how your Social Security will be taxed, that is why you are still reading this, right? Social Security taxation is based on your provisional income.  Your provisional income is equal to your adjusted gross income (AGI) plus nontaxable interest (think municipal bonds), plus 50% of your SS benefits. The provisional income total is then applied to the following income limits to determine your actual tax rate. For this conversation, I am just talking federal income taxation; you may owe additional taxes at the state level, depending on where you live.

Income Range With No Taxes On Social Security

When your provisional income falls below $25,000 as a single filer or $32,000 as a married filer, no taxes will be owed on Social Security benefits. Big win on the tax front, not such a big win on the standard of living.  I know I couldn’t pay my property taxes and electric bill with that amount of income. Let alone have the retirement I’ve worked hard for.

Income Range Where 50% of Social Security Is Taxable

For those with a provisional income between $25,001 and $34,000 filing single, or $32,001 and $44,000 filing as married jointly, just 50% of your Social Security benefits will be taxed at your marginal tax rate. For 2019, most of your income would likely fall into the 12% federal income tax bracket.

Income Range Where Social Security is 85% Taxable

When you earn more, you will end up paying more in taxes. With a provisional income at $34,001 and above for single files, or $44,001 and above when filing jointly, 85% of your Social Security benefit will be taxed at your marginal tax rate. For reference, in 2019, the top tax rate under the Trump Tax Plan is 37%. 

Your Social Security Earnings Statement

Filing taxes in the US is confusing. However, don’t stress; you won’t have to manually do all the calculations listed above. Each and every January, the Social Security Administration will send out an earning statement to current Social Security recipients, which shows the amount they were paid in SS benefits throughout the past tax year. This statement can be used to fill in your federal income tax return. Your tax software or tax pro will do all the math for you. PHEW! All the same, you should have a sense of these Social Security taxation rules, so you don’t get surprised with a big tax bill, that you may or may not have the money to pay.

When retirees receiving Social Security benefits anticipate owing taxes on their benefits, they have the option to make estimated quarterly tax payments. You also have the option to have federal taxes withheld from your Social Security checks. Think of this like the payroll taxes taken out of your paycheck.

Roth IRAs and Social Security Taxation

A Roth IRA is one of the most common ways to get tax-free income in retirement.

When investing in a ROTH IRA, you make contributions with after-tax dollars.  Since taxes have already been paid on the income used to fund these accounts, you will not owe taxes on your withdrawals from a ROTH IRA in retirement. When you are calculating your provisional income for Social Security taxation, your ROTH IRA withdrawals will not be counted. This is another reason why it is a great idea to have at least some money in a ROTH IRA as part of your comprehensive retirement income plan. 

State Taxes on Social Security Benefits

We have been discussing the taxation of Social Security benefits at the federal level. Depending on which state you are a resident of, you may also owe state income taxes on your Social Security retirement income.

The good news is that just 13 states collect at least some taxes on your Social Security income. There are four states (West Virginia, Minnesota, North Dakota, and Vermont) that follow that same Social Security taxation rules as the federal government.

The other nine states that tax Social Security benefits also follow the federal taxation rules, but also offer some exemptions and deductions based on your income level and age. This will likely translate into lower taxation at the state level of your Social Security benefits in retirement. Just so you know the other nine states that tax Social Security are Colorado, Connecticut, Kansas, Missouri, Montana, Nebraska, New Mexico, Rhode Island, and Utah.

The good news for residents of the other thirty-seven states and Washington D.C. is you will not owe taxes on your Social Security at the state level.  In other words, Social Security income is tax-free (at the state level) in these 37 states. Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming are the seven states that don’t tax their residents incomes.

The Health Of Social Security

Changes are coming to Social Security in 2020 and beyond.  It is expected that 2020 will be the first year that Social Security pays out more benefits than it takes in via payroll taxes. This unfortunate occurrence is expected to continue well into the future. I don’t see it changing without some major alteration to the US workforce, Social Security benefits or Social Security payroll taxes.

Social Security is a benefit you and your employer(s) have paid into over your working career. Currently, payroll taxes for Social Security and Medicare specifically are 7.65%. 15.3% if you count both the employee and employer contributions. For those of you who are self-employed, bravo, but you get to pay both sides, as employee and employee, for a total of 15.3% as well. Small business owners should consider heavily funding a Solo 401(k) to help minimize their tax bills.

To be clear, your current taxes are not being saved into some Social Security trust fund account waiting for you personally to use in retirement. The money is used to pay benefits to current retirees.  With the hope that future workers will continue to pay into the system to fund your benefits when you eventually retire.

While I hope you have a plan to pay the least amount of taxes in retirement, I also hope you have most of your Social Security benefit subject to income taxes. This would likely mean you have saved and built up a nice retirement nest egg to have a nice standard of living in retirement.