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One of the biggest surprises would-be retirees face when planning their retirement finances is the fact that their Social Security benefits could very well be subject to income tax.
A financial advisor can help you plan for Social Security and potentially minimize your tax bill on your benefits. Connect with a fiduciary advisor today.
One reason for the confusion is that they never saw their parents or grandparents pay taxes on their benefits. However, more and more retirees are likely to pay taxes on their benefits going forward. As of 2022, approximately 48% of Social Security recipients were paying federal income taxes on their benefits – a number that’s expected to rise to around 56% by 2050, according to an analysis published by the Social Security Administration.
Due to rule changes first signed into law by President Ronald Reagan and later expanded by President Bill Clinton, Social Security recipients can face taxes on up to 85% of their benefits depending on their other sources of income. The formula for calculating the tax is called “combined income” or “provisional income,” and it’s not exactly simple.
You can calculate your provisional or combined income by adding half of your annual Social Security benefits to your adjusted gross income (AGI), plus any nontaxable interest paid to you. From there, income brackets determine how much your benefits are considered taxable income.
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Less than $25,000 as a single filer
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Less than $32,000 as a joint filer
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Between $25,000 and $34,000 as a single filer
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Between $32,000 and $44,000 as a joint filer
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More than $34,00 as a single filer
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More than $44,000 as a joint filer
For example, say you receive $2,800 per month in Social Security in 2025, meaning you’ll collect $33,600 in total benefits for the year. Now, imagine that you’ll also withdraw $30,000 from an IRA. As a result, your provisional income would be $46,800 ($16,800 + $30,000). As a single tax-filer, you would be taxed on up to 85% of your benefits since your provisional income exceeds the $34,000 threshold. According to this IRS calculator, you’d pay income taxes on $15,380 of your benefits.
Remember, a financial advisor can help you better understand your tax liability in retirement, including how much of your benefits will be taxable and strategies for mitigating these taxes.