Will My Social Security Be Taxed?
So when it comes to Social Security, we're always asking questions, how much will my benefits be? What about spousal benefits? Do I qualify for those? How does that work? Also, maybe survivor benefits.
Jacob:But also one of the big questions is going be taxation. Will they be taxed whenever I'm receiving my benefits? There's a chance that they actually will not be taxed. Welcome to Retirement Answers, a podcast built to answer your most pressing retirement questions. If If you're someone who's either thinking about retirement or already in retirement, well, you're in the right place.
Jacob:Hey there. My name is Jacob Duke, and each week, I'll be walking through different tips and strategies to help you succeed in retirement. So let's go ahead and get started with today's show. Will my Social Security be taxed? That's one of the biggest questions that my clients are asking, and for good reason.
Jacob:You've paid into the system over your working career and now when it comes time to take your benefits in retirement, the question is, will I be taxed again on those benefits? I already paid a tax to put my money into the system. Am I going get taxed whenever I take that money out in benefits whenever I'm in retirement? And the short answer to that question is that your Social Security is subject to taxation. Now, that does not mean that you will actually pay income taxes on your Social Security benefits because Social Security is not taxed the same way as normal income.
Jacob:We're gonna dive into this here in just a minute. But before we get started, I wanna introduce myself. My name is Jacob Duke. I'm the host here of the Retirement Answers podcast, but also the founder of River Tree Wealth. I'm really glad you're here with me today.
Jacob:So when it comes to Social Security, we're always asking questions, how much will my benefits be? What about spousal benefits? Do I qualify for those? How does that work? Also, maybe survivor benefits.
Jacob:But also one of the big questions is going to be taxation. Will they be taxed whenever I'm receiving my benefits? And like I just said, there's a chance that they actually will not be taxed. And how that works is, at most, 85% of your Social Security benefits will be taxed at any given point. So for example, this is not possible, but just for an example, if you have $100,000 of Social Security benefits, only $85,000 of that $100,000 would ever be subject to taxation.
Jacob:So 85% of your benefits is the maximum amount that could be taxed, not the full 100% of what you are receiving. So that's the first thing. Now, the second thing is this, you could actually pay zero income taxes on all of your benefits. So you have this range of 0% all the way to 85% of your benefits could be taxable as income. And so we're gonna walk through how that works today.
Jacob:We're gonna just kind of walk through this three part process to get to the result, to see how much of your benefits are taxable, but then also see what your total income tax would be. So I'm going to break this down, hopefully make it understandable for you. But then also at the end, I want to give you some tips on how you can reduce this Social Security tax through proper planning and some different ideas that I think would be beneficial for you. So let's go ahead and jump in. Social Security taxation is very reliant on your other sources of income.
Jacob:So, we have to think about W-two wages or salary, or perhaps self employment income, perhaps dividends or interests in a brokerage account or rental income, anything that goes on to your tax return that would be included in your AGI, your adjusted gross income, that's the other sources of income that we're talking about here. So if you have no other sources of income and your only source of income in retirement is your Social Security benefits, you will pay no income taxes on those benefits. Now, as soon as you start adding other income to your Social Security benefits, that means that you could be increasing the taxes on your benefits, which means making it taxable at least in part. So we're going to walk through this and the formula that you kind of have to go through here in a second. So whenever we think about these other incomes, again, it could be earned income, it could be distributions from a retirement account, such as a traditional IRA, a four zero one ks or a four zero three.
Jacob:Obviously your Roth accounts are not included in this because those are tax free. Assuming that you are 59.5 and you've met that five year rule, all distributions will be taxable. But then again, we're not going get into that today. We're just going to assume that all Roth distributions are tax free. Also, dividends and interest from a brokerage account that you might have, any of that would fall into your AGI, therefore it would be factored into the calculations we're determining how much of your Social Security benefits are taxable.
Jacob:So, your income plays a big part in your overall taxation of Social Security benefits. This is why planning is so important. And we're going to dive into some suggestions and ideas and thoughts for you here in just a minute around how you can use this to your advantage. So how are Social Security benefits and taxes around them calculated? Well, there's a three part process and we've got to understand what this process looks like and why it's important.
Jacob:So the first question is, if you have other income, do I just add Social Security to that and then whatever it is, that's my total AGI? Well, not exactly. Your Social Security income is not taxed the exact same way. There's a formula to get to see how much of your benefits are truly taxable. So, we have to go through this three step equation, and I'm going explain the steps, but then I'm also going to go through an example of this with some real numbers here in just a moment.
Jacob:So, the first step is to find what's called your combined income. Now, if you go back to the Social Security Administration website, you can do some research on this and see what that looks like and the definition of it. But your combined income is your adjusted gross income, so all other income sources like we just talked about a minute ago, which is IRA distributions, earned income, dividends, interest, anything like that. But we have to also add in your non taxable interest. Now, this could be interest that you've earned on municipal bonds, for example.
Jacob:So those are technically tax free for you. But we have to add that interest back into your Social Security calculation here to see how much your combined income will be. So, we've got adjusted gross income, which is all the normal sources of income, but also we add in your non taxable interest, which could be municipal bond interest. And then the important part here is we have to take one half of your Social Security benefits. So if you've got $60,000 of benefits in your household, you would add $30,000 into this calculation to find your combined income, not the full $60,000 that you technically are getting.
Jacob:Okay, so that's the first thing. We've got to find your combined income and that's the formula to do it. Adjusted gross income plus non taxable interest plus one half of your Social Security income. The second step is you have to run this total, this combined income, through the combined income tax brackets. Now, brackets are not necessarily telling you what your tax rate is on your Social Security benefits.
Jacob:What this is doing is figuring out how much of your benefits are actually taxable. So, for a single filer, these brackets are as follows: The first $25,000 of your combined income means 0% of that is taxable. The next $9,000 so $25,000 to $34,000 if you're single, 50% of that range is actually taxable in terms of your Social Security being taxable, and then $34,000 or more of your combined income. So if you have more than $34,000 of combined income, then anything that falls above that, 85% of that amount would be subject to taxation. So again, we're gonna walk through an example here in a second to kind of make some sense of this because that might be really confusing, just at first thought or first glance there.
Jacob:So that's step two. We've got to figure out, we've to run the total combined income through these brackets. And these brackets are progressive. So they're like our normal income tax brackets, meaning the first 25,000, 0% of that is taxable. And then the next 9,000, 50% of that is taxable.
Jacob:And then 85% of the amount above 34. So if your combined income is above 34,000, that does not mean that 85% of that full amount is actually taxable. It's only the portion above the $34,000 mark. So again, that's progressive, so it's important to understand that. Now, just really quickly, the brackets for married filing jointly, instead of it being zero to 25,000, it's zero to 32,000, and then it goes from 32 to 44, and then 44 and beyond.
Jacob:So they're slightly higher for those are married filing jointly. Again, we're going go through an example here in a second. Now, after we put your combined income through these tax brackets, you're going to know how much of your Social Security is taxable. So take that amount and add it to all the other sources of income that we have as well. So, if you have IRA distributions or earned income, you're going to add those dollars to the amount we just determined was taxable in terms of your Social Security, and that is your AGI that will go on your tax return.
Jacob:So, this is probably clear as mud. So let's go ahead and walk through an example using some real numbers here. So here's going be some of the facts of what we're doing. Let's assume that you're single. Assume that your Social Security benefits are $3,000 a month or $36,000 a year, and you're also taking an IRA distribution of $20,000 So your total income is 56,000 So if we go back to the first step, we've got to figure out what your combined income is.
Jacob:That means we take your other sources of income, such as that IRA distribution of $20,000 we add in any non taxable interest, which in this case we technically don't have, Also, take onetwo of the Social Security amount that you're receiving. So, if $36,000 is the amount, that means $18,000 is half of that. So, we take $20,000 which is your IRA distribution, we add $18,000 to that, and that gives us a combined income of $38 k. Now, the second step is we have to take that $38 k and put that through those combined income brackets that I referred to earlier. So again, for a single tax filer, it's $0 to $25 k.
Jacob:0% of everything that falls in that is taxable. 25,000 to 34,000, 50% of the range in there is taxable. And then anything 34,000 or above, 85% of that amount is taxable. So the first 25,000 of this 38 which is the combined income here in this example, none of that is going be taxable with at least $13,000 left over. Now the next $9,000 50% of that $9,000 is taxable, so $4,500 is taxable.
Jacob:And then that leaves us $4,000 which would be above that $34,000 mark. So $38,000 minus 34,000 that's how we get that $4,000 that's above that. And then 85% of that $4,000 is taxable, so that comes out to $3,400 So what we've done here is we've run this through the brackets, now we have to total up how much is taxable from each bracket. So the first bracket, remember, zero to 25, 0% of that is taxable, so that's a zero. And then the second bracket, half of that amount is taxable, which means 4,500.
Jacob:So we're going to take that 4,500 and we're going to add that to the amount in the third bracket, which is 85% of that amount would be taxable, which came out to $3,400 in this instance. And so $4,500 plus $3,400 $7,900 Now what this is telling us, this is telling us that that is how much of the Social Security benefit we've received is subject to taxation. So we received $36,000 in total benefits, but only $7,900 are actually subject to taxation. So that's the important part here. Just right there, can see that receiving social security income is a benefit to you because it is going to be way less taxable than normal income.
Jacob:If you receive $36,000 of normal income, every dollar is taxable. But if you receive $36,000 of your Social Security benefits, again, 5% of that amount is the most that could be taxable. But in this instance, with only $20,000 of other income, which is the IRA distribution, you can see that only $7,900 of your Social Security is truly subject to taxation. Now, the third and final step in this is we have to take that 7,900, we have to add that back to your $20,000 of your IRA distributions, and that equals 27,900. So what you can see immediately, so that is your new total AGI, 27,500, but your total income was 56,000 whenever you had the 20,000 plus the 36 from Social Security benefits.
Jacob:So about half is actually taxable. Half of your $56,000 is actually taxable. Now, what you would do next is as a single tax filer, you would subtract out your standard deduction of 13,000 or $14,000 however much it is depending on the year you're watching this. And then you would be left with around 10,000 to $15,000 left over. So that you would put through your normal income tax brackets and figure out how much tax you pay total on your total income.
Jacob:So this shows that your Social Security income is actually much more favorably taxed than any other source of income. Now if there were no IRA distributions, so in this example we used 20,000 but if your only source of income was the $36,000 of benefits and you had no other income, you could have Roth IRA distributions and that would not be taxable. But if you had $36,000 of benefits and that's it on your tax return, none of that $36,000 would truly be taxable. And so what you can do maybe as a way to test this out is I would say go run that 36,000 using that formula I talked about just a minute ago. Use that and follow that three step process and you'll figure out for yourself, hey, that 0% of my $36,000 of Social Security benefits is actually taxable.
Jacob:And that would be the best way to do that after you subtract out that standard deduction when you get to that point. So here are a few of the things that we've learned so far. At most, 85% of your Social Security benefits are taxable at any given point. But your benefits could be completely tax free. So anywhere from zero to 85% of your benefits could be subject to taxation.
Jacob:And this is important because it shows us that your social security is not treated the same as normal income, which is a benefit to you as a retiree. With all these facts kind of understood, I wanted to share some ideas around how you can use this to your advantage. The first thing is I wanted to remind you that tax diversification is important and it matters to your overall taxes in the future. For example, let's go back to the idea that we just had a second ago. We had $36,000 of Social Security benefits, but we also had $20,000 of IRA distributions.
Jacob:If that $20,000 came from a Roth IRA, again, you would still have the same total income of $56,000 but none of your total benefits, none of your total income would ever be taxable because the extra $20,000 came from a Roth IRA. The $20,000 coming from a traditional IRA makes part of your $36,000 of benefits taxable. So that's one example of tax diversification. If we can have money across the tax deferred, tax free and taxable bucket, such as a brokerage account, we can spread out our income sources to help maneuver through these tax brackets and figure out what is the most optimal way to get as much income possible at the lowest tax rate out there. So, it's actually possible to have about $100,000 of total income in retirement completely tax free.
Jacob:I'm going do a video on this shortly, so if you want to see that, be sure to subscribe to my YouTube channel and you can go watch that. But that's going be coming out here pretty soon. And this is going to show you how you can have $100,000 of total income completely tax free in retirement, but it's only because you can be tax diversified. So if you're tax diversified, that is how that is possible. So that's number one, place an importance on being tax diversified just like you want to be diversified in your investments and eliminate the unnecessary risk.
Jacob:Well, are a large risk for retirees, and so we want to be diversified in that way as well. And if all of your money is in tax deferred accounts, I would suggest maybe thinking about how you can plan to get other sources of tax buckets filled out such as a Roth or brokerage account so that you aren't limited in the different ways that you can pull from your accounts in the future. The second tip here is I would say that you can actually convert too much of your money to Roth. So Roth conversions are important for tax planning and lowering your overall tax bill throughout retirement. But a lot of people are solely focused on eliminating the tax deferred account entirely, meaning they're going to convert everything to Roth.
Jacob:And that might not be a terrible idea, but there are some misnomers or some misunderstandings around that because you can actually pull income from your traditional IRA and not pay income tax on it if you do this correctly. So going back to this $36,000 example of Social Security income plus $20,000 of IRA distributions we had, if we lower that IRA distribution amount down to $5,000 or somewhere in that range, can actually take that $5,000 out of our IRA completely tax free and our Social Security would also be tax free as well. That's because of how Social Security taxes are calculated. So just know that you can convert too much to your Roth. I've seen many people come in and they say, Jacob, I'm trying to get everything to Roth so I don't have to worry about taxes ever again.
Jacob:And that's not a bad idea, but you could actually keep some money in your traditional IRA and use that in retirement at those low income tax brackets or perhaps 0% income tax bracket in terms of your distributions. Also, if your RMDs are going to be the amount that you actually need to pull from your portfolio, you might wanna think about leaving some money in there so that you can use those RMDs at those low tax brackets. So that's the second tip or idea for you is don't convert everything to Roth just because you think Roth is better. Evaluate it and say, there a way to convert enough to Roth? And then actually leave some in that tax deferred account so that you have some more tax favorability in the future and can get money out of your tax deferred accounts at a 0% tax rate.
Jacob:The third idea I have for you is that delaying your Social Security benefit, yes, it's going to increase your benefits over time, but it could also decrease your future taxes on those benefits by increasing the benefits you're going to receive. Here's an example. Let's say you could take your benefits right now at 62 and get $25,000 a year. Or you could take it at 67, let's assume that's your full retirement age and get $36,000 a year. So if you do the math on that, say I need $50,000 a year to actually live in retirement and you wait till 67,000 that means $36,000 of that $50,000 would be taken care of leaving $14,000 left over.
Jacob:Or if you take it at 62,000 and $25,000 the amount that means you need $25,000 to make up that gap. Obviously, you're going have cost living adjustments along the way, so that gap might get closed just a touch. But, just for an example, let's just say that that's the case. Whenever you do that, you have to pull the other $25,000 from somewhere, which means more taxable income if you have to pull that from a tax deferred account. You delay your benefits and can get 36,000 of the 50,000 in the future at $67,000 beyond, that means that $1,414,000 dollars is all you have to take from your accounts now.
Jacob:We just saw an example of how adding additional income to your Social Security benefits actually increases the amount of your benefits that are taxable. So if we can lower that amount we have to distribute from our tax deferred sources or taxable sources, that means less of our Social Security benefits will be taxable. So what you can see here is if delay your benefits, you're increasing them, yes, but you're also going to be perhaps decreasing your total tax on them because they're going to make up a larger percentage of your overall income need. And so what you can do then is if you delay your benefits, you can take from your tax deferred sources in those years, what we call your gap years from let's say '62 to '67. You're reducing the amount of tax deferred balance you have, but you're paying income taxes at the lowest rates possible (the 1012% brackets) on the amount you're pulling from your IRA.
Jacob:So that's just another thought delaying your benefits definitely increases them over time, but they also could reduce the amount of tax you pay on your benefits because you can do some planning and navigation around how do I withdraw from my tax deferred sources in a thoughtful way? And the fourth tip or idea for you is understanding how Social Security taxation works will help you build a better plan for your retirement. So a lot of people are just like, I'm just going take it at 62 because I want to get my benefits, and then neglect or don't think about all the implications of doing it that way. So understanding how this works might give you some different thoughts or ideas around how you can plan a more thoughtful or better retirement overall from a tax standpoint. Hopefully this has been helpful for you.
Jacob:So with all that said, I hope this makes sense. Again, I'm going have a video coming out shortly around how this works and an example. I'm going to use a couple different numbers to do that, both single and married filing jointly. And, and hopefully that will bring more clarity as well. But if you have questions, feel free to shoot me an email.
Jacob:It should be linked down in the description of this below. And then, I'd be happy to have a conversation with you there to clear anything up. Thanks for tuning into this week's episode of Retirement Answers. I look forward to talking with you again next week. Hey, it's Jacob again, and I wanted to extend a quick offer to you.
Jacob:If you have a question and you would like to have it answered here on the show, please email me at jacobretirementanswers dot net. And I'd love to answer that question for you right here on the show. Also, wanted to remind you that nothing discussed in today's episode is meant to be financial, legal, or tax advice. Retirement Answers is for educational purposes only. Thanks for tuning into this week's episode.
Jacob:I look forward to talking with you again next week.
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