Social Security: How your benefits are taxed
If you’re wondering how your Social Security benefits are taxed, you’re not alone – Social Security benefits are taxed differently than most other income sources. We’ve outlined how Social Security taxes work and what, if anything, you can do to reduce your tax burden.
How Social Security is taxed
The amount of your Social Security benefit that's subject to federal taxes is based on your provisional income (sometimes called your combined income). Your provisional income is equal to the sum of your adjusted gross income, nontaxable interest and half your annual Social Security benefit.
How to calculate provisional income
This image shows how provisional income is calculated using icons; provisional income (wallet) is the sum of your adjusted gross income (balance scale) plus nontaxable interest (piece of paper) plus half your annual Social Security benefits (hand holding a lock).
This image shows how provisional income is calculated using icons; provisional income (wallet) is the sum of your adjusted gross income (balance scale) plus nontaxable interest (piece of paper) plus half your annual Social Security benefits (hand holding a lock).
Percent of Social Security benefit subject to federal taxes
The provisional income thresholds aren't adjusted annually for inflation. As a result, more of your benefits may be subject to taxes over time due to annual cost-of-living adjustments to your Social Security benefit and/or larger retirement account withdrawals.
In addition, certain states tax Social Security benefits. If you live in one of these states, you may need to factor this additional liability into your retirement income strategy.
How to reduce and prepare for Social Security taxes
Given how low the tax thresholds are, most people won't be able to avoid Social Security taxes altogether. However, you may be able to reduce your Social Security taxes by taking withdrawals from your Roth accounts to meet your retirement income needs.
Qualified withdrawals from a Roth account aren't factored into your provisional income, so it may make sense to tap into it at times to manage your taxes. Keep in mind, though, that you're giving up future tax-free growth on the withdrawn assets, which may be especially important if you want to leave an after-tax legacy for your heirs. You'll want to weigh the trade-off of saving on taxes today against the potential for future tax-free growth.
If you don't have a Roth IRA today, you can convert your traditional IRA to a Roth IRA to gain access to tax-free distributions in the future. However, you’ll have to pay taxes the year you convert your funds, which may cause an increase in Social Security taxes in the year of conversion.
To prepare for your Social Security taxes and avoid an underpayment penalty, you can file IRS Form W-4V with the Social Security Administration and request to have 7%, 10%, 12% or 22% of your monthly benefits withheld. Fortunately, you are not locked into one rate forever. You can change it, if you like, based on changes in your financial picture. You can also set aside additional cash to meet your potential tax liability if you expect to be taxed at a higher rate.
How we can help
Though it may be tempting, reducing your current tax burden as much as possible shouldn’t be the only consideration when it comes to managing your retirement strategy. Your Edward Jones financial advisor and qualified tax professional can help you determine the best overall retirement income strategy for you.