Thanks to Social Security benefits, you may have the financial resources you need to retire. According to the Washington Post, an $18,000 annual benefit equates to about $200,000 that you've earned toward your retirement, assuming an average life expectancy. The problem is, of course, that the value of any annuity is calculated in pretax dollars.
To understand the annual, actual value of your Social Security benefits requires a little more work, including gaining an understanding of the tax you'll pay on those benefits.
Changes in Retirement Income
Your retirement income is likely to result from a variety of things, from personal assets to employer and Social Security benefits. The problem is that each of these assets undergoes changes at different points in your life and those changes can mean that you must adjust your expectations and your way of living from time to time. These mental adjustments may be due, in no small part, to federal and state taxes that reduce the size of the Social Security benefits that you receive.
Read More: Which Incomes Reduce Social Security?
Combined Income and Income Thresholds
Whether you owe tax on your Social Security benefits depends in part on IRS-defined income thresholds and your "combined income."
Income Thresholds 2020: If your income is greater than $25,000 per year and you file an individual federal tax return, you may pay taxes on your Social Security benefits. The same is true for those filing jointly with annual earnings greater than $32,000. These thresholds apply whether your Social Security benefits take the form of retirement, spousal, survivor or disability payments.
Combined Income 2020: Whether you file an individual tax return or a joint return, your combined income determines what part of your Social Security benefits are taxed at the federal level. Whether you file an individual return or a joint return, combined income is the sum of the adjusted gross income, nontaxable interest and one half of your Social Security benefits that you are reporting.
According to the 2020 IRS rules:
- If you file an individual return and have a combined income of $25,000 to $34,000, 50 percent of your Social Security benefits may be taxed.
If you file a 2020 individual return and your combined income is greater than $34,000, as much as 85 percent of your benefits are taxable.
If you file a joint return and your combined income is between $32,000 and $44,000, about 50 percent of your Social Security benefits may be taxed.
- If you file a joint return with a combined income of more than $44,000, 85 percent of your benefits are subject to federal tax.
Examples of Tax Scenarios
File as Individual in 2020: Assume that you're single and you received $28,000 in Social Security benefits in 2019. Also assume that you had additional income of $15,000 and received $500 in tax-exempt interest. Half of your benefits, or $14,000, plus your other income of $15,500 gives you a combined income of $29,500. In this case, your income is below the 2020 $34,000 threshold for an individual filer, so only 50 percent of your $28,000 Social Security benefits are subject to federal income tax.
Married Filing Jointly in 2020: Assume that you're married and that you receive $20,000 in Social Security benefits and your spouse receives $18,000. Also assume that you and your spouse had additional income of $25,000 plus $1,000 in tax-exempt interest. In this case, half of your combined benefits – plus your other income – totals $45,000, an amount that exceeds the threshold of $44,000 for those filing jointly. Consequently, up to 85 percent of your total Social Security benefits are subject to income tax.
Read More: How Do Income Taxes Work?
State Tax on Benefits
The tax law of states differs from federal tax law regarding Social Security benefits. Of the 50 states, only 13 tax Social Security benefits. Of those 13, some tax a portion of your benefits, rather than their entirety.
Whereas twenty-six states impose no state tax or exclude Social Security benefits from taxable income, the tax law of two states – Utah and Nebraska – mirror federal tax law regarding Social Security retirement benefits. An additional 12 states tax Social Security benefits but exempt some portion of the benefits that are taxed at the federal level. Still, other states place limits on the benefits taxed according to the filer’s age or income level.
Due to great differences in state tax law, it’s essential that you carefully review your state’s laws to understand the rules and thresholds that affect your tax return. Visit TaxAdmin.org and search for your state to find additional particulars, such as tax rates and income brackets, that relate to your state’s tax code.
For some receiving Social Security benefits, navigating the sea of regulations, deductions, taxes and exemptions is troublesome. Before you pay your taxes, it might be a good idea to talk to an accountant or tax advisor. A professional may provide the insight you need to make knowledge-based decisions regarding your Social Security benefits, which can make filing your tax return a less burdensome task.
- Tax Foundation: State and Local Sales Tax Rates, 2020
- Tax Admin: State Individual Income Taxes
- SSA: Retirement Benefits
- Washington Post: Thanks to Social Security, You Are Probably in Better Shape for Retirement Than You Think
- Social Security Administration. "Retirement Benefits," Page 2. Accessed Feb. 19, 2020.
- Internal Revenue Service. "Publication 554: Tax Guide for Seniors," Page 12. Accessed Feb. 19, 2020.
- AARP. "Which States Tax Social Security Benefits?" Accessed Feb. 19, 2020.
- Iowa Legislature. "Senate File 2408 - Enrolled." Accessed Feb. 19, 2020.
- New Mexico Taxation and Revenue Department. "Does New Mexico offer a tax break to retirees?" Accessed Feb. 19, 2020.
Billie Nordmeyer is an IT consultant of 25 years standing. As a senior technical consultant for SAP America and Deloitte Touche DRT Systems, a business analyst, senior staff, and independent consultant, Billie has worked across the retail, oil and gas, pharmaceutical, aeronautics and banking industries. Billie holds a BSBA accounting, MBA finance, MA international management as well as the Business Analyst and Software Project Management certificates from the Cockrell School of Engineering at the University of Texas at Austin.