What You Can Do About Taxes on Social Security Benefits sponsored by Todd Carmack
Once you are the legal age to pay income taxes, this will continue until the day you pass. There is no avoiding it. You will have to pay taxes on withdrawals from any tax-deferred retirement savings plans. You may also be liable for taxes on your Social Security payments.
According to a survey done by American Advisors Group, about 50 percent of baby boomers expect their Social Security benefits to be their primary or only source of income. This is why taxes could be detrimental to retirees.
Well, the good news is that you may be able to lessen or even avoid the impact of these taxes on your Social Security benefits.
The first way to do this is by having your annual retirement income fall under federal income limitations. You SS payments can be liable for taxes at the state and federal level. What you pay at the federal level, if you must pay taxes, depends on how much income you have coming in.
How much you need to pay in taxes is based on your combined income, which is half of your yearly SS benefit, nontaxable interest, and gross income. For instance, if you are getting $18,500 from Social Security and have withdrawn $25,000 from your IRA, you would combine $9,250 plus the $25,000, which adds up to $34,250 as your total combined income.
To start, the maximum portion of your benefits that the IRS can tax is 85 percent if you earn more than their limit.
Single filers do not have to pay any taxes if they have a combined income of less than $25,000 a year. Those that are married and filing jointly do not have to pay taxes if they have a combined income of less than $32,000 a year.
Single filers that have a combined income of $25,000 to $34,000 may have up to 50 percent of their Social Security benefits taxed. Those that are married and filing jointly will be liable for up to 50 percent of their benefits if they have a combined income of $32,000 to $44,000 a year.
Single filers that have a combined income of over $34,000 will face up to 85 percent of their benefits being taxed. Those that are married and filing jointly will have up to 85 percent of their benefits taxed if they have over $44,000 in combined annual income.
You may have noticed that to pay zero dollars on taxes for your Social Security payments, you must have a combined income of less than $25,000 if you are a single filer and $32,000 if you are married and filing together. For many, it is not worth having an intentionally low income to skip paying taxes on your Social Security benefits.
But if you have your savings in a Roth IRA, the withdrawals you make in retirement will not be considered in your combined income calculations as you have already paid taxes on the money you put into the Roth account. So, if you do it right, you can have a retirement income that is more than the income limit without having to pay taxes if you have your savings in a Roth IRA. This will also have you exempted from income taxes on your annual retirement income and Social Security payments.
Now, when it comes to state taxes on Social Security benefits, this depends on what state you plan to retire in as not every state taxes SS payments.
The states that do not tax SS benefits include Alabama, Alaska, Arizona, Arkansas, California, Colorado, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, Nevada, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Virginia, Washington, Wisconsin, and Wyoming.
Soon, West Virginia will also not tax Social Security benefits by the year 2022.
There might be bad news for retired residents in Illinois as their tax laws may be changed to start taxing Social Security payments. This is something to keep an eye out for updates.
Though reducing or being able to avoid taxes altogether is a great way to keep a good amount of money to yourself for retirement, other things can be done to maximize your retirement income. You also don’t want to overlook other items to save yourself money on taxes. For instance, if you are considering a move to another state that does not tax Social Security benefits, be sure to do your research on what other taxes the state does tax and at what rates compared to the current one you live in. Also, be sure to know what the cost of living is compared to where you are living right now. Overall, be sure to do the math to make sure that the move will benefit you in saving money.
As mentioned, you may also want to see what other things you can do to lessen the tax impact you might be facing when you become a retiree. Investing or rolling your savings into a Roth IRA may save you money in taxes, but you can also investigate contributing some of your savings into a health savings account (HSA). This type of account lets you invest pre-tax money and let it grow tax-free. You can also make withdrawals from it tax-free if used for qualified medical expenses.
If your Social Security benefits will be your primary source of money during your retirement years, it is important to maximize these benefits as much as you can. Though saving cash by reducing taxes is one method, it is very crucial to be pragmatic and strategic with your plans for retirement overall.
It is recommended to do as much research as possible to understand what challenges you may face in retirement so that you best prepare for it.