More and more retirees are being taxed on Social Security benefits. Legislative changes over the decade have shaped the age of receipt, amount of benefits and taxation over the decades, meaning many Americans unexpectedly will face taxation on the public program paid into during their working years. For someone starting their Social Security benefits at or around $3,200 in 2024, it’s likely that at least some of it will get taxed if you have some other source of retirement income. The question is, by how much.
Up to 85% of Social Security benefits can be taxed based on your other income sources. The provisional income formula, which is central to calculating the taxes on your Social Security benefits, adds half of your annual Social Security benefits with your adjusted gross income (AGI) and any nontaxable interest, such as from municipal bonds. This total then determines the taxable portion of Social Security benefits across different income thresholds.
Benefits are not taxed if:
Single filers: Your provisional income is below $25,000
Married filing jointly: Your provisional income is below $32,000
Up to 50% of benefits become taxable if:
Single filers: Your provisional income is between $25,000 and $34,000
Married filing jointly: Your provisional income is between $32,000 to $44,000.
Above these brackets, up to 85% of benefits may be taxed.
For instance, receiving $3,200 monthly in Social Security totals to $38,400 annually. Let’s say you also withdraw $50,000 from an IRA in the same year. This makes your provisional income $69,200 ($19,200 + $50,000). If you’re a single filer, this is above the $34,000 provisional income threshold, meaning that 85% of your benefit will be taxed.
$38,400 annual Social Security benefit x 85% = $32,640 taxable benefits
This is an oversimplified example, but a financial advisor can walk you through calculations and other projections. Any amount of your Social Security benefit that is subject to taxation will be taxed at your marginal income tax rate. For 2024, these rates are as follows, depending on your adjusted gross income:
Marginal Tax Rates for 2024
Tax Rate: 10%: Single Filers ≤ $11,600 Married Filing Jointly ≤ $23,200 12%: Single Filers > $11,600 Married Filing Jointly > $23,200 22%: Single Filers > $47,150 Married Filing Jointly > $94,300 24%: Single Filers > $100,525 Married Filing Jointly > $201,050 32%: Single Filers > $191,950 Married Filing Jointly > $383,900 35%: Single Filers > $243,725 Married Filing Jointly > $487,450 37%: Single Filers > $609,350 Married Filing Jointly > $731,200
To potentially lower the taxes on your Social Security benefits, consider these strategies:
1. Delay or Reduce Retirement Account Withdrawals: Lowering withdrawals from tax-deferred accounts like IRAs or 401(k)s decreases provisional income. Opting for withdrawals from a Roth IRA or Roth 401(k), which are not considered taxable income, can also be beneficial.
2. Manage Required Minimum Distributions (RMDs): Currently, RMDs become mandatory once you turn 73. If still employed with an active 401(k), RMDs from that account are not required. Qualified charitable distributions from an IRA can satisfy RMDs without counting as taxable income.
3. Roth Conversion:Converting to a Roth IRA allows for tax-free qualified withdrawals in the future and such withdrawals do not contribute to provisional income. When reasonable, it’s wise to convert amounts that keep Social Security taxation at 50% or less.
4. Avoid the “Tax Torpedo”: The inclusion of taxable Social Security benefits can potentially push you into a higher tax bracket, known as the “tax torpedo” effect. Strategic planning of all retirement income sources is crucial to mitigate this. Consulting a financial advisor can provide personalized guidance to navigate these complexities.
Effectively managing and reducing the taxes on your Social Security benefits requires careful planning and strategy. By understanding the impact of various income sources on the taxation of benefits and exploring tax minimization strategies, retirees can better prepare for their financial future. Engaging with a financial advisor may offer further personalized insights and assistance in avoiding common tax pitfalls associated with retirement.
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