According to the IRS, roughly 46% of current beneficiaries pay taxes on social security. Will you pay taxes on your social security benefits? If so, how much of your social security will be taxable? These are questions that many retirees and pre-retirees ask themselves as they plan for their retirement income. Social security taxation is surprisingly complex. The amount of your benefits that will be taxable depends upon your filing status and combined income.
Combined Income
The IRS uses a formula called combined income to determine how much of your Social Security benefits are taxable. Here’s the formula:
Adjusted Gross Income (excluding Social Security)
- Nontaxable Interest (eg. Municipal Bond Interest)
- ½ of your Social Security Benefits
= Your combined income
Combined Income Thresholds
The IRS has different income cut-off points for the maximum amount of your social security that is taxable:
The higher your combined income, the more of your Social Security benefits are subject to taxes.
Calculating the Taxable Amount of Social Security
This is where things get especially confusing. The actual amount of your social security that is taxable may be less than the maximum amount shown in the table above.
If your combined income puts you into the 50% bracket, the actual taxable amount of social security will be the lesser of:
- 50% of social security
- 50% of Combined Income over the lower threshold
- Lower Threshold Single = $25K
- Lower Threshold Married Filing Jointly = $32K
If your combined income puts you into the 85% bracket, the actual taxable amount of social security will be the lesser of:
- 85% of social security
- 50% of social security + 85% of Combined Income over the top threshold
- Upper Threshold Single = $34K
- Upper Threshold Married Filing Jointly = $44K
- 50% of Combined Income over the lower threshold + 35% of Combined Income over the higher threshold
Here’s a graphic showing this information:
Taxation of Social Security Example
Let’s look at an example to see how this works. Assume the following income:
Pension: $25K
Capital Gains: $5K
Social Security: $20K
First, let’s use the formula to determine combined income:
This combined income puts a single filer into the 85% bracket and a Married Filing Joint couple into the 50% bracket. How much of the social security will be taxable for each filing status?
Here’s a look at the calculations:
Single (85% Bracket Calculation):
The lowest of the three calculations results in a taxable amount of $9,600. Note that this means 48% of this taxpayer’s benefits are taxable even though they are in the 85% cut-off bracket.
Married Filing Jointly (50% Bracket Calculation):
The lowest of the two calculations results in a taxable amount of $4,000. Once again, the actual amount of social security that is taxable is significantly lower than the maximum that the taxpayers could pay. Despite being in that 50% range, the amount of social security that is taxable is only 20%.
Social Security taxation can be complex and confusing. But it doesn’t have to be. At Sophos Wealth Management, we can help you understand how Social Security taxes affect your retirement income and how you can reduce them with smart planning strategies. Whether you need help with choosing when to claim your benefits, optimizing your asset allocation, or creating a tax-efficient withdrawal plan, we have the expertise and experience to help you achieve your retirement goals. Contact us today to schedule a free consultation and find out how we can help you keep more of your hard-earned Social Security benefits.
Scott Caufield, CFA, CPA