After decades of having Social Security taxes withheld from your paycheck, you may not expect to pay taxes on the benefits you’ve earned. But if you have other sources of income, there’s a good chance you’ll pay taxes on up to 85 percent of your benefits. Depending on where you live, your state may tax your benefits, too.
The government started taxing a portion of Social Security benefits 40 years ago as part of an overhaul to shore up the program’s finances.
The formula is based on what Social Security defines as a beneficiary’s provisional income, which is half of your Social Security benefits, plus other sources that contribute to your adjusted gross income, such as wages, withdrawals from certain tax-deferred accounts, dividends, interest, and capital gains from taxable investment accounts. Interest from municipal bonds, which is generally tax-free, is also included in provisional income.
If your provisional income ranges from $25,000 to $34,000 for single filers, or $32,000 to $44,000 for joint filers, up to 50 percent of your benefits will be taxable. If your provisional income is more than $34,000, or $44,000 for joint filers, up to 85 percent of your benefits will be taxable.
These thresholds were never adjusted for inflation, which means the percentage of retirees who pay taxes on their benefits has increased dramatically since the tax was signed into law. In 2020, an estimated 56 percent of retirees were paying taxes on a portion of their benefits, according to the Center for Retirement Research at Boston College.
If most of your retirement income comes from Social Security, you probably won’t have to pay taxes on your benefits. But beneficiaries who have income from other sources will likely owe taxes on a portion of their benefits, says Roger Young, a certified financial planner with T. Rowe.
The tax bite can be severe. Retirees in the 22 percent federal tax bracket with above-average Social Security benefits, for example, could end up paying a marginal tax rate of up to 40.7 percent on their income, according to an analysis by T. Rowe Price. (Keep in mind that your marginal tax rate applies to only a portion of your income, not the entire amount.)
A large cost-of-living adjustment (COLA) in benefits can magnify the tax bite. In 2023, beneficiaries received an 8.7 percent COLA. Because the thresholds are not adjusted for wage growth or inflation, increasing the amount of benefits means more of those payouts will be taxed, thus reducing the net benefit of a cost-of-living increase, Alicia Munnell, director of the Center for Retirement Research, said in a 2021 brief.
Some lawmakers have proposed exempting Social Security benefits from taxes. Others have proposed indexing the thresholds to inflation. But any reforms that would reduce Social Security’s funding are unlikely to go anywhere. Taxes on benefits contributed $47 billion to the program in 2022. In its annual report to Congress in April, the Social Security Board of Trustees said that unless Congress shores up the program, Social Security will be unable to pay retirees their full benefits starting in 2034.
