Or, just some additional income in retirement?
Before you begin calculating your income for the first year of retirement, hear this: You may have to pay federal taxes on your Social Security retirement benefits.
And 12 states also tax Social Security retirement benefits.
Taxes on Social Security may be a surprise to future retirees who are planning ahead.
“It can be a bit of a shock,” says Roger Young, VP, Senior Retirement Insights Manager, T. Rowe Price. But, don’t let this stop you from maxing out your benefits at age 70.
When figuring your budget for the first year of retirement, determine whether your Social Security benefits will be taxed. This will depend on your “combined income” in retirement.
Even before you claim Social Security retirement benefits, estimate what your benefit will be, and calculate to the extent possible, your potential tax bill. “They’ve got to do the math and the math has to include taxes,” Young says.
If you have created a my Social Security account online with the Social Security Administration (SSA), check to see if your estimated future monthly benefits are listed along with your earnings record.
Some people will pay no tax on their Social Security benefits while others will pay tax on up to 50% of their benefits and others, who have more income, will pay tax on up to 85% of their benefits.
“Some part of your Social Security benefits are always exempt from tax,” says Eric Smith, a spokesman for the Internal Revenue Service. “It’s just a matter of what percent.” Some people don’t pay any federal income tax on their Social Security benefits “because their income is low enough,” he says.
There are thresholds above which a higher percentage of your benefits are taxed. “The thresholds have remained unchanged,” Smith says. As incomes have risen more people are paying federal income tax on up to 85% of their Social Security retirement benefits, he says.
In short, if you have “other substantial income” in addition to Social Security benefits, you typically will have to pay federal income tax on part of your Social Security benefits, according to the SSA website.
Other taxable income includes pensions, wages, interest, ordinary dividends, and capital gain distributions, according to the IRS.
The first step is to figure your “combined income.”
Here’s how the formula works:
If your Social Security benefits will be $2,800 per month, for example, your total annual income from Social Security retirement benefits would be $33,600 ($2,800 x 12 = $33,600). Then, multiply $33,600 by 0.5, giving you $16,800 ($33,600 x 0.5 = $16,800). Next, add any other income including pensions, wages, interest, ordinary dividends, and capital gain distributions. Finally, add any tax-exempt interest, such as interest on municipal bonds.
This one-page IRS worksheet can help you figure your combined income, “Read This To See if Your Social Security Benefits May Be Taxable,” Notice 703 (Rev. October 2021) (irs.gov). If you need more information, see IRS publication 915.
Once you have your combined income, you can determine whether and what percentage of your Social Security benefits are subject to federal income tax.
Here are the guidelines:
If you file an ‘individual’ tax return:
and your combined income is $25,000 or less you don’t have to pay tax on your Social Security benefits.
and your combined income is between $25,000 and $34,000, you may pay federal income tax on up to 50% of your benefits.
and your combined income is more than $34,000, you may have to pay federal income tax on up to 85% of your benefits.
If you file a joint return:
and together you have a combined income between $32,000 and $44,000, up to 50 percent of your benefits may be taxed.
and together you have more than $44,000 in combined income, you may have to pay income tax on up to 85% of your benefits.
The majority of states — 38 — do not tax Social Security benefits. However, 12 states do: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, West Virginia. It’s best to check your state’s tax rules and regulations as they can change.
When planning your retirement budget, take taxes into consideration.
“Consider your full financial circumstances and your cash flow,” says
David Sieminski, a policy analyst with the Consumer Financial Protection Bureau. “You may want to have some (income tax) withheld. Some people would rather have it withheld incrementally so they don’t have to write a check” when their taxes are due.
During the transition to claiming Social Security benefits, people don’t necessarily consider how it will affect their income taxes. “It’s the planning process that most people don’t think about,” Sieminski says.
Once you have received benefits, the SSA sends Form SSA-1099 – Social Security Benefit Statement to you each year. It shows the amount of Social Security benefits you received during the previous year.
If you have determined that you’ll pay some tax on your Social Security benefits, and prefer to have taxes withheld from your Social Security, use this form: W-4V, Voluntary Withholding Request. You can choose to have federal income tax withheld at the rate of 7%, 10%, 12% or 22%. Return the signed form to your local Social Security office by mail or in person.
Alternatively, if you will have to pay taxes on your Social Security benefits, you can send the IRS quarterly estimated tax payments.
If you use tax preparation software, it will calculate how much tax you will pay on your Social Security benefits, Smith says.
If you have specific questions about your potential tax liability, check with your tax professional.
Harriet Edleson is author of the book, “12 Ways to Retire on Less: Planning an Affordable Future” (Rowman & Littlefield). A former staff writer/editor/producer for AARP, she writes for The Washington Post Real Estate section.