An essential step in planning for your retirement should be gaining an understanding of your Social Security benefits. This monthly check acts as a safety net, and your decision as to when you start taking benefits can be a life-changer.
Assuming that you have average earnings and you start your benefits at "full retirement age," Social Security benefits will replace about 40 percent of your earned income in 2020. For people with low incomes, it's about 75 percent, but only 27 percent for those in the upper income brackets.
Based on these figures, it's likely you'll need another source of income when you retire. But be aware that in some cases, your Social Security benefits are taxable.
Read More: Social Security Benefits and Tax Thresholds
If you file an individual federal tax return and your income is greater than $25,000 per year, you may owe income taxes on your Social Security benefits, whether those benefits take the form of retirement, spousal, survivor or disability benefits. The same is true if you file a joint return with earnings greater than $32,000. If your income is less than these thresholds, your benefits aren't taxed.
Federal Tax on Social Security Benefits
Your combined income determines what portion of your benefits are subject to federal income tax. The Social Security Administration (SSA) provides the following estimates for 2020 combined income, where combined income equals your adjusted gross income plus nontaxable interest plus one-half of your Social Security benefits:
- If you file a 2020 individual tax return and your combined income is between $25,000 and $34,000, you may owe tax on as much as 50 percent of your Social Security benefits.
- 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 2020 joint return and your combined income is between $32,000 and $44,000, up to 50 percent of your benefits may be taxed.
- If in 2020 you file jointly, and your combined income is more than $44,000, as much as 85 percent of your benefits are taxable.
An example will make the effect of your combined income on the Social Security benefits you receive clearer. Assume your adjusted gross income is $50,000 and your nontaxable interest is $1,500. Also, assume that you receive $1,700 in benefits from Social Security each month. Your combined income is $61,700. In this case, your income is higher than the threshold set by the IRS, so you will pay taxes on 85 percent of your $20,400 annual benefits, or $17,340.
Read More: How to File for Social Security
State Tax on Social Security Benefits
Thirteen of the 50 U.S. states tax a resident's Social Security benefits. These states include 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 state information by visiting the State Tax Agencies page on the Federation of Tax Administrators website and clicking on the state that interests you.
If you're a senior whose sole source of income is a Social Security check, the Internal Revenue Service doesn't require you to pay federal taxes on your benefits. If you're fortunate and have other sources of income, including nontaxable interest, your combined income will determine if you will pay tax on your benefits and, if so, the amount of tax that you will pay.
- SSA: Understanding the Benefits
- SSA: Benefits Planner Income Taxes
- Kiplinger: Calculating Taxes on Social Security Benefits
- SSA: Income Taxes and Your Social Security Benefits
- Kiplinger: 13 States That Tax Social Security Benefits
- Federation of Tax Administrators: State Tax Agencies
- 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.