As retirement gets close, there are lots of questions that soon-to-be retirees have. One common one is whether or not Social Security benefits are taxable - and how much that exactly amounts to. 

As with many financial issues, the answers to these questions depend on other factors. In this case, namely your other sources of income. If you’re taxed, 50-85% of your benefits may be taxed, meaning that you include that percentage of your benefits in your income subject to regular tax rates.

Calculate your numbers

How do you know how much of your benefits are taxed? First, identify what your income is. You’ll need to include all items, even items that may otherwise be left out, like tax-exempt interest. You’ll also need to add your spouse’s income if you file joint tax returns. 

Take this number and add half of the Social Security benefits received by you - and your spouse - during the tax year. The resulting number is your total income plus half your benefits. 

You then apply the rules below to your situation:

• If your income plus half your benefits is lower than $32,000 for joint filers or $25,000 for single filers, your benefits aren’t taxed. 
• If your income plus half your benefits is greater than $32,000 but less than $44,000, you’ll be taxed on half of the amount over $32,000 OR one half of your benefits, whichever number is lower. 

Numbers in action

Let’s look at an example to illustrate how this can work. If you and your spouse together have $20,000 in taxable dividends, $2,400 in tax-exempt interest and combined Social Security benefits equally $21,000, your income plus half of your benefits is $32,900. ($20,000+$2,400 + ½ of $21,000.)

You’d have to include $450 of the benefits in gross income (1/2 ($32,900 − $32,000)). (If your combined Social Security benefits were $5,000, and your income plus half your benefits were $40,000, you would include $2,500 of the benefits in income: 1/2 ($40,000 − $32,000) equals $4,000, but 1/2 the $5,000 of benefits ($2,500) is lower, and the lower figure is used.)

Keep in mind if you don’t pay tax on your Social Security benefits because your income is below the floor or if you pay tax on just 50% of the benefits, an unexpected income boost may triple your tax bill. Why? You’ll need to pay tax on the extra income, tax on your Social Security benefits, and you could end up in a higher marginal tax bracket. 

When does this situation arise? For example, if you get a large distribution from your IRA or you have significant capital gains, you could easily find yourself in this position. However, thoughtful planning can help you prevent negative tax impacts; if you spread your additional income out over multiple years or liquidate assets other than an IRA account, you can better situate yourself and your taxes. 

If you’re anticipating taxes on your Social Security benefits, one solution is to voluntarily arrange for taxes to be withheld from payments via a Form W-4V. This approach can help you avoid making tax payments. 

We know that taxes can be a complex process even in retirement. Smolin Lupin is here to help you find the best solution for your needs. Contact us today for more information.