Social Security Benefits & Tax Thresholds

There’s no doubt that you should treat your Social Security benefits as an asset in your retirement portfolio. But if you’re waiting for a note from the Social Security Administration (SSA) to tell you how much your retirement benefits are worth in a practical sense, you shouldn’t be.

The SSA calculates your monthly benefit according to your salary, the time you worked and so on. But it’s up to you to compute the after-tax contribution of those benefits to your retirement portfolio and understand how they contribute to your retirement goals. Knowing some basic information can prove helpful.

Relative Value of Social Security Benefits

A first step in retirement planning should be acquiring an understanding of Social Security benefits. For many Americans, this monthly benefit check serves as a safety net, particularly for those who choose to include a few risky investments in their retirement portfolios.

For the retiree who has average earnings and starts benefits at "full retirement age," the SSA says those benefits will replace about 40 percent of the person’s earned income in 2020. For a person with low income, it's about ​75 percent,​ but only 27 percent for someone in the upper income brackets.

Income Tax Threshold

A tax threshold is an income level at which you must pay tax or calculate a tax using a certain or different tax rate. Regarding your Social Security benefits, a tax threshold is the income level (for your filing status) at which your Social Security benefits are taxed or the level at which your benefits are subject to a higher tax rate.

In terms of the federal income tax, you are liable for taxes on your Social Security benefits to the extent that your combined income exceeds a tax threshold, whereby combined income is equal to the sum of your adjusted gross income, your nontaxable interest and one-half of your Social Security benefits.

In 2020, if you file an individual federal tax return and your combined i​​ncome exceeds $25,000,​ you must pay taxes on your Social Security benefits. If you and your spouse adopt a married filing jointly tax status, and your combined income is greater than $32,000, you too must pay taxes on earning above that amount. The same is true for spousal, survivor and disability benefits. In a like manner, according to the Internal Revenue Service (IRS), you may have to pay tax on ​85 percent​ of your Social Security benefits if you file a single return and you earn ​more than$34,000​ per year, or file a joint return and your income is ​greater than$44,000​ per year.

Tax Threshold Example

The effect of your combined income on the dollar value of the Social Security benefits you receive is best illustrated by example: Assume that you adopt the single filing status, and your adjusted gross income is $45,000, your nontaxable interest is $3,000 and your monthly Social Security check is $1,600.

In this case, your combined income is the sum of $45,000 plus $3,000, plus one-half of $19,200, or $9,600, for a total combined income of $57,600. Because your combined income of $57,600 is greater than the IRS threshold of $34,000, you will pay taxes on 85 percent of your $19,200 annual Social Security benefits, which equals $16,320.

Whether your income is $34,500 or $2.5 million, and whether you file a single return, a married filing single return or a married filing jointly return, the maximum percent of your Social Security benefits that will be taxed is ​85 percent​.

State Income Tax

In the United States, ​13 states​ tax Social Security benefits: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, North Dakota, Vermont, Utah and West Virginia.

For information on how Social Security benefits are taxed in one of these states, visit the state's tax agency. You can access it by visiting the State Tax Agencies page on the Federation of Tax Administrators website.

Payment of Taxes

If you owe taxes on your benefits, you can pay them in one of two ways: by filing a quarterly estimated tax return with the IRS or by asking the SSA to withhold the federal income tax from you benefit payments.

If you're a senior and a Social Security check is your sole source of income, the IRS doesn't tax your benefits. But if you're fortunate enough to have other sources of income, such as nontaxable interest, your combined income is a determinant of whether you must pay federal or state tax on your benefits and, if so, the amount of tax that will be due.