It is a common belief that one’s Social Security benefits (‘SS”) are provided tax-free.  Generally, that is true.  By there are exceptions. You may be surprised to learn that a portion of your Social Security benefits could be subject to federal income taxes.  We expect to pay income taxes when we have earned income from work but not on our Social Security benefits… we already paid taxes on those earnings when we worked.  This is a harsh reality of retirement for many people and understanding how much of your income will be taxed is a vital part of estate and retirement planning.

The average federal income tax rate on retirement income is 6%, but that number varies greatly, depending upon the total amount of non-Social Security retirement income such as pensions, and IRA  distribution. The lowest income groups may pay next to nothing, but as their income rises, so do the taxes.   You must pay taxes on your Social Security benefits if you file a federal tax return as an “individual” and your “combined income” exceeds $25,000. If you file a joint return, you must pay taxes if you and your spouse have a “combined income” of more than $32,000. If you are married and file a separate return, you probably will have to pay taxes on your benefits. However, no one pays taxes on more than 85% percent of their Social Security benefits. The tax rate is dependent on the regular federal tax sliding scale for  income,  thus the  tax rate is based on the amount of income you are declaring

Income taxes and health costs are most people’s biggest expenses in retirement.  Income taxes remain payable on all pensions (except in some cases where municipal pensions are exempt from taxes as in NYS)  and withdrawals from any deferred accounts including traditional IRAs,  401(k)s 403(b)s, and similar retirement and thrift savings accounts. The same goes for tax-deferred private annuities and Required Minimum Distribution (RMD) which must be taken starting at age 72.  If these are moved then the cited exemption amount noted above,  your Social Security benefits will also be taxed. This needs to be acknowledged and planned for as it will reduce  your available retirement income,

Roth IRA and 401(k) distributions are tax-free since taxes are paid when the funds were deposited into the accounts so since the tax was NOT deferred there is no tax when the funds are withdrawn. Consider the impact of the withdrawal of these funds on the taxation of your SS benefits.

Withdrawal and liquidation from an investment account can also have some “surprise” taxes.  If you have investments in addition to your tax-deferred funds, like stocks or bond funds, you know that you pay taxes on the dividends and interest paid to you each year. In addition, if you sell these stocks and bonds at a profit over your original purchase price, you may need to pay taxes on the profit you made on these investments over the years in the form of capital gains taxes.  This will also dig into your profits.

 Learning that a portion of your Social Security benefits is subject to federal income tax is a shocker to many retirees, but in reality, about 40% of Social Security recipients will pay some taxes on a portion of their benefits. The higher your income, the more taxes you’ll need to pay.   Meet with your financial advisor, your accountant, or our attorneys to carefully strategize which and what additional assets to liquidate to cover your retirement lifestyle Tax impact on your SS benefits and taxes, in general, may make these additional distributions more.

Another shocker for SS recipients who are receiving benefits before their full retirement age (“FRA”)  (usually 66 -67.5)  and who continue to work and may have to forfeit SS benefits. Claiming before FRA means that your benefits are subject to earnings limits – – if you exceed these earning limits SS  benefit reduction will be triggered. Social Security withholds one dollar in benefits for every two dollars earned above the annual earnings limitation. Your full retirement age varies according to the year you were born. The full retirement age used to be 65 for those born in 1937 or earlier. Those born between 1943 and 1954 have a full retirement age of 66. The full retirement age further increases to 66 and six months for people born in 1957, up from 66 and four months for those with the birth year of 1956. “The full retirement age increases for those born in 1957 who attain age 62 in 2019,” says Jim Blair, a former Social Security administrator and lead consultant at Premier Social Security Consulting in Cincinnati, Ohio. “Full retirement age is 66 years, six months. This is a two-month increase over those born in 1956.” The full retirement age will further increase in two-month increments each year until it hits 67 for everyone born in 1960 or later.

Our firm is ready to help you understand social security benefits and your tax implications. Contact us today for more information.