|Taxable Social Security Income|
|Filing Status||Income||Percentage of Social Security That Is Taxable|
|Single, Head of Household, Qualifying Widower, and Married Filing Separately (where the spouses lived apart the entire year)||Below $25,000||All Social Security income is tax free.|
|Same||$25,000 to $34, 000||Up to 50% of Social Security income may be taxable.|
|Same||More than $34,000||Up to 85% of Social Security income may be taxable.|
|Married Filing Jointly||Below $32,000||All Social Security income is tax free.|
|Same||$32,000 to $44,000||Up to 50% of Social Security income may be taxable.|
|Same||More than $44,000||Up to 85% of Social Security income may be taxable.|
Calculating Your Income Level
Filers in the first two categories must calculate their provisional income, also known as modified adjusted gross income (MAGI), by adding tax-exempt interest (such as from municipal bonds), 50% of the year’s Social Security income, and any other tax-free fringe benefits and exclusions to their adjusted gross income and then subtracting adjustments to income (other than education-related and domestic activities deductions).
Jim Lorman is not married. He made $19,500 for the year, plus $2,000 in interest and $1,500 in gaming wins. He also earns $10,000 from Social Security. ($19,500 + $2,000 + $1,500 + $5,000 = $28,000)
Jim’s preliminary income will be $28,000. As a result, he may be required to pay taxes on up to 50% of his Social Security income.
Henry and Sharon Hill have a combined income of $48,000, which includes $4,000 in interest and $3,000 in dividends. Their Social Security payments total $20,000:
$48,000 + $4,000 + $3,000 + $10,000 = $65,000
As a result, their MAGI is $65,000. They might be required to pay taxes on up to 85% of their Social Security income.
You may estimate your taxable Social Security income by consulting IRS Publication 915. Qualified plan members who also made deductible IRA contributions must instead utilize the spreadsheets included in IRS Publication 590-A. According to IRS Publication 915, if you filed as Married Filing Separately and resided with your spouse at any point throughout the year, up to 85% of your Social Security benefits may be taxed, regardless of the amount.
How to Lower Your Social Security Taxes
For people who are taxed on their Social Security income, there are numerous options. The most apparent answer is to decrease or remove the inclusion of interest and dividends in the provisional income calculation. In all of the above situations, the taxpayers would have paid less Social Security tax if they had not had declarable investment income on top of their other income.
Thus, the remedy may be to convert the reportable investment income into tax-deferred income, such as an annuity, which will not appear on a Form 1040 until it is withdrawn. If you have $200,000 in certificates of deposit (CDs) generating 3% per year, it will be considered provisional income. When determining provisional income, the same $200,000 accumulating within an annuity with the interest recycled back into the annuity would effectively generate a reportable interest of $0.
Depending on the account type, annuities often constitute taxable income when distributed. Almost every investor who does not spend all of the income earned on a CD or other taxable instrument may profit by transferring at least some of his or her assets to a tax-deferred investment or account.
Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia are the states that tax Social Security.
Earmarking Retirement Accounts
Another option is to work fewer hours, particularly if you are at or near the threshold for having your benefits taxed. In the first case, if Jim moved his taxable assets into an annuity and earned $1,000 less, he would have almost no taxable advantages. Transferring investments from taxable accounts to a conventional or Roth IRA achieves the same result, provided funding restrictions are not exceeded.
IRA Contribution Limits
The IRS has set contribution restrictions for new money deposited into an IRA. For 2021 and 2022, the annual contribution maximum for both regular and Roth IRAs is $6,000 per year. Individuals over the age of 50 may make a $1,000 catch-up donation every year. The annual contribution maximum for a 401(k) is $19,500 in 2021 and $20,500 in 2022. If you are 50 or older, you may contribute an extra $6,500 every year as a catch-up contribution.
One popular method is to take assets from tax-sheltered retirement accounts, such as IRAs and 401(k)s, early (or “make distributions” in retirement terminology). Remember that you may make distributions penalty-free beyond the age of 5912. That means you won’t have to incur the penalty for making these withdrawals too soon. If you take your IRA money before the age of 5912, you will typically face a 10% penalty in addition to paying income taxes on the distribution.
Because any withdrawals are taxed, they must be carefully planned in conjunction with the other taxes you will have to pay on income for the year. The idea is to pay less tax by withdrawing more during this pre-Social Security period than you would once you start drawing benefits. This necessitates taking into account the overall tax bite from withdrawals, Social Security income, and any other sources.
Remember that you must take required minimum distributions (RMDs) from these accounts at the age of 72, so you must prepare for those mandated withdrawals.
The Bottom Line
There are several laws governing the taxability of Social Security payments, and this page aims to address just the most important rules and concerns. Visit the IRS website and obtain IRS Publication 915 for further information on this issue, or see your tax professional.