What You Should Know about Taxes and Social Security Benefits
Will your tax bill this year include taxes on your Social Security benefits? Approximately 55 million people receive monthly Social Security payments, and some of them pay taxes on up to 85% of those benefits depending on their financial situation. Will you have to ante up to Uncle Sam when you begin to collect Social Security? If you’re not certain—or if you’re currently being taxed on your benefits—the Texas Society of CPAs offers advice on ways to minimize the tax effects of Social Security benefits.
Determine When to Take Payments
Before even thinking about taxes, the first step is to figure out the best time to start collecting Social Security payments in order to maximize your benefits. While 65 was once the universal age when people left work and began collecting Social Security and other pension benefits, that is no longer the case. Today, the Social Security “full retirement age” for those born in 1937 or earlier is 65, but it rises gradually for those born in later years and tops out at 67 for anyone born after 1959. If you qualify for benefits and are planning when to begin taking them, be aware that you will receive higher monthly payments if you wait longer to begin collection.
You can start collecting benefits as early as 62, but the amount you receive will be less than what you would get at full retirement age. If you hold out until age 70, however, you will get a yearly percentage increase to your benefits calculated based on the year you were born. Thus, at age 70, benefits no longer continue to increase even if you continue to delay taking them. Since the average lifespan keeps lengthening, you may want to consider delaying your benefits so that you receive the highest amount when you need it. Of course, your decision will be affected by numerous factors such as your financial situation or health. Your CPA can help you determine what’s best for you.
Know How and When Social Security Is Taxed
If Social Security benefits are your sole source of income, it’s unlikely you will owe taxes on them. However, if you receive any other income or take distributions from retirement plans, you may have to pay taxes on your Social Security benefits. There’s a relatively simple calculation to find out if Social Security benefits are taxable. Begin by taking the total Social Security benefits received each year and divide it in half. For example, say you receive $14,400 annually in Social Security benefits. One-half would be $7,200. Add that amount plus any nontaxable interest, such as interest from certain state or municipal bonds, to adjusted gross income. Now compare it to what is called the “base amount.” The current base amount is $25,000 for those who are single, head of household, or a qualifying widow or widower, and $32,000 for married people filing jointly. Social Security income above that base amount may be taxable.
Adopt Smart Strategies
One strategy to minimize or eliminate the taxes you might pay on your Social Security benefits is to invest in a mix of taxable and nontaxable income. For example, the distribution you take from a traditional IRA will be taxable and is included in the income you compare against your base amount. On the other hand, a qualified distribution from a Roth IRA is tax free, as is a withdrawal from a non-retirement savings account. With that in mind, you may want to build a retirement portfolio that includes some nontaxable income.
Your CPA Can Help
Your Social Security income, and the taxes you may pay on it, is one consideration in your overall retirement plan. Your local CPA can help create a retirement savings program aimed at producing the most available income in retirement to minimize your tax bite. Be sure to consult with him or her with all your financial questions.
Copyright The American Institute of Certified Public Accountants.
| American Institute of Certified Public Accountants
||Texas State Board of Public Accountancy