Broker Check
Taxes and Retirement - Part 3

Taxes and Retirement - Part 3

| February 21, 2024

This week we are going to talk about Social Security benefits which are an important component of any retirement income plan. Many retirees are surprised to learn that their Social Security income can be taxed, and taxed a lot! Let’s talk about how it works.

The general rule of thumb is that if your retirement income is above $25,000 per year, and this includes income from all your income sources, your Social Security will be taxed. On the other hand, if Social Security is the only source of income you have it is likely you won’t have to pay any taxes on those payments. This is critical to consider when creating your retirement income plan because as we discussed earlier, accounting for and reducing taxable income should be part of your planning process. Regardless of what your total retirement is, your Social Security benefits will never be taxed more than 85%.

If your benefits are taxed there are ways to reduce the impact. One way is to convert a traditional 401(k) or IRA to a Roth 401(k) or Roth IRA as these types of accounts provide tax-free income except for the year they are converted. Another way to reduce the tax impact on your Social Security benefits is to use investments that provide nontaxable income like municipal bonds, tax-exempt mutual funds, or ETFs, for example. You can also delay the tax payments on your Social Security benefits by not claiming benefits right away. There are numerous advantages to doing this that we will talk about in the coming months.

The first step is to figure out if your Social Security will be taxed. To do that we first have to understand how the amount of your benefit is determined by the IRS. The way they do this is by looking at your AGI or Adjusted Gross Income. This is your total taxable income and it includes this like the money you earn from your job, distributions from 401(k) plans or your IRAs, and any taxable income you make from your investments like dividends or interest from taxable accounts. Next, the IRA will subtract any tax deductions and the number they get is your AGI.

But wait, they aren’t done just yet. Next, they add two components to that AGI number. The first is your nontaxable interest and the second is half of the amount of your Social Security benefit. That new number is what is called your “combined income”. This is the number the IRS uses to determine if your Social Security will be taxed. So, this year if your combined income is more than $34,000 if you are single and $44,000 for couples they can tax up to 85% of your Social Security benefit. 

If you are thinking that those numbers seem really low, you are right! That is why you should safely plan on having your Social Security benefit taxed to avoid surprises and make sure to employ some of those tax reduction strategies and accounts we’ve talked about so far this month to soften the blow. In my experience, about half of your retirement income comes from Social Security so it is especially important to manage this correctly and get the most out of your money!

Join me next week when we will wrap up our month on taxes in retirement with a discussion of how you can protect your beneficiaries from the effect of taxes.

Until next time…

One last thought: We believe an educated investor is an empowered investor. If you like what you’ve read and think your friends and family can benefit as well, please share.


Social Security Is Taxable? How to Minimize Taxes | Charles Schwab 

This material was created for educational and informational purposes only and is not intended as tax, legal or investment advice. Please consult your tax professional for your specific situation