Social Security benefits are a key piece of many folks’ retirement plans. For many folks, they are the only piece. A 2020 report by the National Institute on Retirement Security, for instance, found that approximately 40.2 percent of retirees receive all their retirement income from Social Security, and none from a defined benefit plan (such as a pension or annuity) or defined contribution plan (such as a 401(k) or IRA). That same report found that only 6.8 percent of retirees received all three types of retirement income. If Social Security is in your future (or your present!), you need to be aware of some tax issues that may impact your benefits.
The Social Security Act was signed into law on August 14, 1935. One of its major provisions was to provide continuing income to retired workers after age 65. Nearly 71 million people received some form of Social Security benefits in 2022, including 51.3 million retired workers receiving an average benefit of $1825 per month.
There are multiple types of Social Security benefits beyond just retirement benefits. In this article, I am only discussing retirement benefits.
How are Social Security retirement benefits calculated?
Social Security retirement benefits are based on your earnings history and the age at which you begin receiving benefits. You can check your earnings history and expected future retirement benefit by logging into your account on the Social Security website. If you do not have a login, create one today!
You may also qualify for spousal or survivor benefits. Some folks may wish to receive spousal benefits initially and then switch to their own later to maximize the benefits they will receive in the long term.
The Social Security retirement benefits estimator will default to using your most recent year of reported earnings as your expected future earnings, but you can change those amounts (even to $0 for early retirement!) to get a more accurate picture.
Are Social Security benefits taxable?
There is a widespread perception that Social Security benefits are nontaxable. For many folks, this turns out to be true. I work with many retirees whose primary income comes from Social Security that end up paying no taxes. For many other folks, though, that is not the case.
Up to 85 percent of your Social Security retirement benefits may be taxable. The specific percentage depends on the amount of your total income, including both Social Security and non-Social Security income. Yes, you read that right: Your non-Social Security income impacts the percentage of your Social Security retirement benefits that are taxable. This is important to remember because your income can change from year-to-year, particularly if you have multiple streams of income.
When planning out your annual budget, you need to consider what percentage of your Social Security benefits will be taxable to accurately estimate your annual tax liability. Consult the instructions for Form 1040 or the IRS online tool to help you determine this amount. Add the taxable portion of your Social Security benefits to the remainder of your taxable income so you can determine your tax liability for the year.
Last year, I assisted a couple that typically has zero federal tax liability since the bulk of their income consists of Social Security retirement benefits. However, in 2023, they had a large capital gain from a land sale causing them to owe both federal and state taxes. Fortunately, they had planned for this event and set aside a portion of the sale proceeds to meet their tax obligations.
What about state taxes?
Besides federal taxes, you may also need to consider state taxes. Retirement benefits, interest, dividends, and capital gains are sourced to the state where you live at the time you receive the income. While most states use your federal income (including the taxable portion of your Social Security benefits) as the basis for determining state tax liability, some states may allow you to exclude Social Security and other retirement benefits.
Do I need to file a return if none of my Social Security benefits are taxable?
If none of your Social Security benefits are taxable, you may still have a filing requirement—even when you ultimately have no tax liability. Whether you must file a tax return depends on your total income, age, and filing status. Every year, I work with a handful of retired folks that have sufficient income (some of which is taxable and some of which is nontaxable) to generate a filing requirement, but they have no tax liability because the taxable portion of their income is below their standard or itemized deductions for the year.
State requirements can further complicate the question of whether you must file a tax return. It is possible to have no federal filing requirement but still have a state filing requirement.
When in doubt, file a tax return.
How do I pay taxes on my Social Security retirement benefits?
There are two ways to pay taxes on your Social Security benefits: either directly or through withholdings.
The way most folks handle these taxes is to pay the IRS (and their state, if applicable) directly. Remember the basic steps to completing your tax return: (1) add your income (including the taxable portion of your Social Security benefits), (2) subtract adjustments to get adjusted gross income, (3) subtract standard or itemized deductions to get taxable income, (4) figure tax liability based on taxable income, (5) subtract any credits and add any additional taxes to get net tax, (6) add withholdings and estimated tax payments made throughout the year, and (7) compare the results from steps 5 and 6 to determine whether you receive a refund (if your withholdings and payments exceed your net tax) or have a balance due (if your net tax exceeds your withholdings and payments). If you have a balance due, simply pay by the deadline. If you have a large enough balance due, you may have an additional penalty for not paying enough throughout the year; avoid this penalty by making estimated tax payments.
Besides direct payments—whether periodic estimated payments or a year-end balance due—you can have federal income taxes withheld from your Social Security benefits. Simply complete Form W-4V and mail it to the nearest Social Security office. This option obviates the need to make quarterly estimated payments. Be aware, though, that you cannot have state taxes withheld from your Social Security benefits, so you may still need to make state estimated tax payments or be prepared to pay a state balance due.
If you receive other types of income besides Social Security, you may be able to increase federal and/or state withholdings from your non-Social Security income. As long as the total amount withheld for the year is sufficient to cover your tax liability, the specific source of that withholding is irrelevant. For example, your tax return (and overall cash flow) is the same whether you have $2,000 withheld from Social Security and none from your IRA distributions, $1,000 each from Social Security and IRA distributions, or none from Social Security and $2,000 from IRA distributions.
This sounds like a lot. Can Phippen Tax help?
Wrapping your head around meeting your tax obligations in retirement can be daunting, so reach out to me for help if this seems overwhelming! We will chart out a path to help you enjoy a less taxing life by minimizing your tax liability and planning for meeting those obligations with the least amount of stress.
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