Social Security is not always exempt from taxes.
You are entering retirement soon.
You expect to receive Social Security benefits.
Did you know Social Security can be taxed up to a rate of 85 percent?
Yikes!
Can you estimate how much might be subject to tax?
According to a recent Investopedia’s article “How to Avoid the Social Security Tax Trap,” taxable Social Security is based on a formula.
You can add up your gross income with certain adjustments.
Where do you find this?
It will be the amount on line 21 of Form 1040.
You must then add back any excluded income.
This includes foreign earned income, U.S. Savings bonds used for higher education, and employer adoption benefits.
Next find the amount listed on Form SSA 1099 sent by the Social Security Administration.
The benefits are the gross amount listed in Box 3.
All tax-exempt interest from municipal bonds is listed on Form 1040 line 8a.
If you are below $32,000 if married and filing jointly, or $25,000 if single, head of household, widowed or married filing separately, you will not be taxed on Social Security.
If the income mix is between $25,000 and $34,000 for those for those filing as singles, you will be taxed at 50 percent.
If more than $34,000 it will be taxed at 85 percent.
What if you are married and filing jointly?
Income between $32,000 and $44,000 will be 50 percent.
If more than $44,000 it will be taxed at 85 percent.
There are exceptions.
What are they?
You will use a different formula if you or your spouse were covered by a qualified retirement plan through self-employment or another job or if you made deductible IRA contributions.
You will use IRS Publication 915, if you repaid any Social Security benefits throughout the year.
If you received benefits for a previous year, this year you will use worksheets in IRS Publication 915.
You may want to convert a traditional IRA to a Roth IRA and pay taxes on it this year.
Why?
You will not need to take any Required Minimum Distributions on the money in the future.
This will give you more control in keeping your income lower and below the taxable level.
In addition to federal taxation, your state may also tax Social Security.
Only thirteen states fall into this category.
Seven of these states have rather high thresholds for taxing benefits.
This means you may not be taxed even if you have reside on one of these states.
Fortunately, Kansas and Missouri are both states with a high threshold.
There are other states where those who qualify for federal taxation will also be taxed by the state.
You may want to avoid these states in retirement.
They include Minnesota, Vermont, North Dakota, and West Virginia.
Work with an experienced estate planning attorney and certified financial advisor if you have questions about tax-effective planning.
Remember: “An ounce of prevention is worth a pound of cure.” When making your financial, tax and estate plans, do not go it alone. Be sure to engage competent professional counsel.
Reference: Investopedia (March 13, 2018) “How to Avoid the Social Security Tax Trap”
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