Get ready to be royally ticked off.
If you pay enough taxes into Social Security during your career, you’ll be entitled to a monthly benefit once you retire. But there are a number of reasons why that benefit may be smaller than you’d expect.
If you don’t work for 35 years, you may get stuck with a less generous benefit, since Social Security factors your 35 highest-paid years of earnings into its calculations. And if you file for Social Security before reaching full retirement age, your monthly benefits will be reduced.
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But there’s a less obvious reason why you might lose out on some of your Social Security income. And it’s a frustrating one at that.
When taxes get in the way
You might assume that your Social Security benefits are yours to keep free and clear of taxes. But that’s not automatically the case.
Depending on your total income picture, you may be subject to taxes on a large portion of your monthly Social Security checks. To see if this is the case, you’ll need to calculate your provisional or combined income, which is basically your non-Social Security income plus half of your annual benefit.
Here’s where things get worse. The thresholds for combined income are almost ridiculously low based on today’s living costs.
For singles, a combined income between $25,000 and $34,000 means you may have to pay taxes on up to 50% of your Social Security benefits. Once your combined income exceeds $34,000, you risk being taxed on 85% of your Social Security benefits.
To be clear, this doesn’t mean you’ll lose 50% or 85% of your benefit checks to the IRS. Rather, that percentage of your benefits may be subject to taxes. So if your monthly benefit is $2,000, between $1,000 and $1,700 of it may be taxable. And from there, you’ll lose a portion of whichever sum applies to you.
For married couples, the combined income thresholds aren’t much higher. If your combined income is between $32,000 and $44,000, you could face taxes on up to 50% of your monthly Social Security checks. Beyond $44,000, up to 85% of your benefits may be taxable.
The reason these thresholds are so low is that they were established decades ago and haven’t been updated to account for inflation. And that’s surprising given that Social Security benefits are eligible for an annual cost-of-living adjustment that’s inflation-based. But nevertheless, these thresholds remain, which means that if you have a decent amount of retirement income overall, you may not get to keep all of your Social Security.
How to avoid paying taxes on Social Security
If the idea of having to pay taxes on Social Security aggravates you, you’re in good company. But thankfully, there is something you can do about it — save for retirement in a Roth account.
The nice thing about Roth retirement plan withdrawals is that they’re not considered taxable income, and they also don’t count toward your combined income. So let’s say you’re single and collect $48,000 a year from Social Security, or $2,000 per month, which is a notch above the average retired worker’s monthly benefit today.
Half of your annual Social Security benefit is $24,000, which puts you just below the $25,000 combined income threshold where taxes could start to apply. But if your only other retirement income source is the $30,000 a year you take out of your Roth IRA, you’re in the clear with regard to paying taxes on your Social Security checks.
If you earn too much money to fund a Roth IRA directly, you can contribute to a traditional IRA and convert it to a Roth afterward. And Roth 401(k)s aren’t subject to income limits. So if you have access to an employer plan that offers this savings option, you may want to take it for the sake of protecting your future Social Security benefits.
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