Taxes on Social Security

A Simplified View

How much you owe in taxes on Social Security income can be a big shock.

I clearly remember that it was one of my Dad’s biggest retirement surprises. He didn’t expect to pay so much in taxes. Yet there it was…a big tax bill in the first year of retirement. Like a lot of other retirees, he didn’t know that up to 85% of his Social Security benefit could be counted as taxable income.

Social Security Tax

Ultimately, we were able to mitigate some of his tax burden, but for some of it, he was stuck.

He didn’t like it and he’s not alone.  Every year individuals retire and are faced with sticker shock when they find out how much they’ll have to pay in taxes on Social Security income. To some, it doesn’t seem fair. You’ve worked for years and paid your Social Security tax as the admission ticket to a Social Security benefit. Now that you’re collecting that benefit, you have to pay taxes?  Again?

At first, Social Security benefits were not taxable. That all changed with the passage of 1983 Amendments to the Social Security Act. Under this new rule, up to 50% of Social Security benefits became taxable for certain individuals. 10 years later, the Deficit Reduction Act of 1993 expanded the taxation of Social Security benefits. Under this Act, an additional bracket was added where up to 85% of Social Security benefits could be taxable above certain thresholds.

The combination of these laws left us with the current tax structure on Social Security benefits. Today, somewhere between 0% and 85% of your Social Security payment will be included as taxable income. In order to determine how much of your Social Security benefits will be taxable, you first have to calculate “provisional income” – a measurement of income used specifically for this purpose. Provisional income can be roughly calculated as your total income from taxable sources, plus any tax exempt interest (such as interest from tax free bonds), plus any excluded foreign income, plus 50% of your Social Security benefits.  

Social Security Tax Provisional Income

Once you’ve calculated your “provisional income” you can apply it to the threshold tables to determine what percentage of your Social Security will be included as taxable income.

If your total “provisional income” is less than $32,000 ($25,000 if single), none of your Social Security benefits will be taxable.  However, if you are married and your total exceeds $32,000 ($25,000 for singles), then 50% of the excess is the amount of Social Security benefits that must be included in taxable income. If your provisional income exceeds $44,000 ($34,000 for singles), then 85% of the excess amount is included in income. 

Social Security Provisional Income Threshholds

That can seem confusing so let’s look at an example.  Tim and Donna have recently retired.  They have some rental property that generally averages $12,000 in net annual income.  Their combined Social Security benefit will be $3,000 per month ($36,000 p/yr).  In addition to this income, they will take an annual distribution from their IRA in the amount of $32,000.

Retirement Income and Calculating Provisional Income

Using the income from those sources, here’s how the provisional income would be calculated.  Remember that only 1/2 of the Social Security income is counted.

Social Security Provisional Income Calculation

Now that the provisional income is calculated, it’s time to find out how much of their Social Security benefit is taxable. Based on a married couple with a provisional income of $62,000, it’s now a simple matter of applying the income to the thresholds.

The first $32,000 of the provisional income has no impact on whether or not a Social Security benefit is taxable.  50% of the amounts between $32,000 and $44,000 will be added.  85% of the amount in excess of $44,000 will be added.

As a rough calculation, a married couple with a provisional income of $62,000 would have $21,300 of taxable Social Security income (see chart below).

dollar amount of Social Security income that is taxable

Since you can only spend the dollars you keep, you need to be familiar with the rules about when and how much you may pay in taxes on Social Security.  You don’t have to be a tax expert…I know I’m not. I do understand enough to know how to roughly calculate the amount of taxable Social Security benefits.  You should too.  For anything deeper, see your tax advisor.

High taxes in retirement is a surprise that can often be avoided.