October 19, 2023
I know that for many of you nearing retirement, your Social Security benefit will be a significant source of monthly income.
That makes it extra important to understand whether you might owe income tax on your benefit. Or if you’re the adult child of a parent who will soon be collecting, you need to know this too! If your parent is going to be on a tight budget in retirement, it’s best to know now if their income will be further reduced by tax owed. Right now you all have more flexibility and choice in how to make sure a parent’s after-tax retirement income will support their expected spending needs (and wants).
And unfortunately, taxes kick in at relatively low levels of income.
Who doesn’t owe tax on their Social Security benefit:
The only people who don’t owe some tax on their Social Security benefit are individuals with a combined income below $25,000 or a spouse filing a joint tax return with a combined income below $32,000.
The key is what the IRS means by combined income:
Combined income =
Adjusted Gross Income + Nontaxable Interest + 50% of your Social Security benefit
Nontaxable interest is any income you receive from municipal bonds or bond funds. Yep, you read that right. While municipal bond interest is tax-free on your federal return, the amount you receive is a factor in whether you will owe tax on your Social Security benefit.
Who pays income tax on up to 50% of their Social Security benefit:
Who pays income tax on up to 85% of their Social Security benefit:
Do those limits seem low? Well, they haven’t changed since this tax went into effect in 1984. Back then, very few people receiving benefits were hit with the tax. Now it’s quite common to owe tax on your Social Security benefit. According to the IRS, in the 2021 tax year, nearly 23 million returns included Social Security income that was subject to federal taxation.
Benefits may also be taxed by your state as well.
If all of this is news to you, consider yourself lucky. Yes, lucky! I would rather you find out now and consider any changes you might want to make in your retirement plan. Maybe you save more now. It’s also another great reason to consider building up savings in a Roth IRA or Roth 401(k). Qualified withdrawals you take from a Roth are not counted as part of your adjusted gross income. Qualified means you are at least 59 ½ when you make the withdrawal, and the account was opened at least five years ago.