When You Must Pay Taxes on Social Security Benefits

Taxes on Social Security Benefits. J.J. Gouin/Shutterstock

Income taxes are often high enough during your working years, but some people will have to pay taxes during their retirement—on their Social Security income. Even though they paid into the system for years, the Internal Revenue Service (IRS) still wants a portion when they start receiving their benefits. As many as 56 percent of people on Social Security pay taxes on their benefits.

Like all other federal taxes, these taxes are based on your income. When you retire, you may have multiple sources of income that include pensions, retirement accounts such as IRAs or 401(k)s, and more. When added together, your income could easily surpass the income levels permitted.

The good news is that if your only retirement income is from Social Security, it is doubtful that you will owe any taxes on it. Since the allowable income levels are rather low, almost any other income stream from a retirement account (or part-time job) could cause you to pay taxes on your Social Security.

The Income Limits Defined

When the IRS looks for taxable money, it counts all your income. The IRS says supplemental security income (SSI) payments are an exception. These payments are not taxable and are not considered part of your income.

When calculating your income, you only count half of your Social Security benefits and all other income (you must include tax-exempt interest). Individuals (including heads of household and a qualifying surviving spouse) earning $25,000–34,000 will have to pay tax on half their benefits. This ceiling level also applies to married people who file separately but have lived apart for the entire year. When singles earn more than $34,000, as much as 85 percent of their Social Security benefits are taxable. The remaining 15 percent will never be taxed.

Married couples that file jointly earning $32,000–44,000 will have to pay taxes on half of their Social Security benefits. If they are still married but lived with their spouse for any time during the year, all income is taxable. When married couples filing jointly earn more than $44,000 combined, they will pay taxes on up to 85 percent of their benefits.

Supplemental Security Income payments are not taxable. The AARP says that children who receive dependent or survivor benefits may need to file and pay taxes if their income exceeds the basic income levels.

Some States Also Tax Retirement Benefits

Besides paying tax on your Social Security benefits to the IRS, you may live in a state where it also collects taxes on retirement benefits. Investor.Vanguard says that 13 states currently tax Social Security income. They include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia. Some of these states may be changing who they tax in the next few years.

If you want to avoid the additional state taxes on your retirement income and possibly other income if you work beyond your full retirement age, you may consider moving to a different state. Some states do not charge income taxes, which will help keep more money in your pocket. They may, however, charge higher property taxes than other states.

How to Reduce or Eliminate Social Security Taxes

Having more income that puts you above the tax-free limits means you need to reduce it to fit within those tiers. If you are not yet receiving money from an IRA or 401(k), you can convert it to a Roth 401(k) or a Roth IRA. These retirement accounts do not have any required minimum distributions, enabling you to keep it in the account as long as you want—and it keeps growing.

When you make the conversion, you must pay taxes on the conversion amount. Taxes are due because money put into a traditional IRA or 401(k) is contributed tax-free, enabling you to get a tax deduction. The one catch on conversion is that the money must be in the account for five years before getting any tax-free withdrawals.

Another tactic that can reduce your income, Schwab says, is to delay taking Social Security benefits. You can delay these benefits as long as you want, but it will stop growing when you reach 70. The one possible negative aspect of this move is that the longer you wait to get Social Security, the more your benefits increase—by 8 percent each year until age 70.

You can overcome this problem by reducing benefits from other retirement accounts. Take your Social Security benefits at age 70 and reduce your other benefits. At the same time, people with larger incomes, NerdWallet says, may also want to reduce their income to lower the higher cost they will be paying for Medicare parts B and D.

You can also reduce your income by contributing to charitable organizations from retirement accounts. They must be made directly from your IRA or 401(k) accounts without withdrawing it.

Taxes Can Be Withheld From Your Social Security Benefits

Near the start of each year, you will receive a statement from the Social Security Administration (SSA) informing you how much is owed in Social Security taxes from the previous year. Once you know that amount, the SSA says you can make estimated tax payments quarterly, or you can have the government withhold the taxes for you by going to SSA.

If you are not yet receiving Social Security retirement benefits, you can develop a strategy with a financial advisor as to the best way to reduce your taxes. People already getting Social Security benefits should talk to a financial expert to learn their best tactics for tax reduction tips.

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