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How Taxes Are Determined on Social Security

Kevin Wenke

Kevin Wenke

CFP | CLU | Investing | Insurance | Taxes

Social Security income is taxed the same for both retirement and disability benefits. Determining how much tax one pays on Social Security income is done with a formula which provides some great tax planning opportunities.

You have to understand that when Social Security first started out all retirement income benefits to retirees were 100% income tax free. 

The taxes worker’s pay through the Federal Insurance Contributory Act, or FICA, are taken with after tax dollars and originally provided every worker with income in retirement free from any further tax. 

That changed in 1984 when certain higher income individuals started to have at least half their income taxed.  Another change happened in 1993 when the IRS started taxing up to 85% of higher income earning recipients so the IRS is slowly reducing retirees benefits indirectly through increased taxes.

Still though, today this means at least 15% of everyone’s Social Security is completely income tax free but many are taxed far less receiving 50% or 100% of their social security benefits benefits income tax free. 

How could you ensure that you pay the least amount of tax possible on you Social Security retirement?

To answer that question you have to know what determines whether or not Social Security income will be 100%, 50% or just 15% income tax free?

The determination comes down to a formula that calculates what is known as “Adjusted Gross Income” or AGI.  Depending on a taxpayers AGI, they could end up in one of two tiers indicating how much of their social security taxed.

50% of Adjusted Gross Income above the first tier but below the second tier is subject to income tax; 85% of income above the second tier is subject to income tax.

The income subject to taxes would be taxable at whatever tax bracket the retiree was in the year it was received.

The greater your AGI the less of your Social Security will be tax free.  Of, course the opposite is true – lower AGI will expose a lower percentage of Social Security income to tax

A good question to think about is what income raises up your AGI causing social security to be taxed?  The answer may surprise you!

First of all, only half of your household Social Security counts toward AGI.  If you have $30,000 in Social Security, only $15,000 counts toward AGI so if you were single and had no other income, you are still below the $25,000 AGI level and 100% of you Social Security would be tax free.

Any earned income counts toward AGI as well – If you are still working BEFORE full retirement age you also have to be aware of the earnings test – I have another video like this one for that below Earned income, pension income, and dividends received all count toward AGI.  

Here is a trick question: Do tax free municipal bonds count toward AGI?  The answer is Yes!  The interest itself is tax-free, but that income counts toward AGI and could cause Social Security to be taxed.

Other incomes that count towards AGI are capital gains in non-qualified accounts.  If you sell a stock, bond or piece of real estate and make money then you increase your AGI.

Income from distributions from traditional retirement plans like IRAs and 401(k)s also increase AGI.  That is a good representation of income that will increase AGI but you might be wondering if there is income that won’t increase AGI.

Yes.  ROTH IRA income does not push up AGI as long as you followed the rules when you take out the earnings. 

That means you have to have had the ROTH for 5 years and be over 59 ½ years old.  As a matter of fact, you could receive millions of dollars a year from ROTH IRA distributions and not pay a penny in tax on your social security because not one cent is counted towards AGI.

And that is how taxes are determined on Social Security Income in 2020.  What the future has in store is anyone’s guess. 

If you want my opinion and some other interesting thoughts, get my report called “Overcome Social Security Confusion” which I have shared a link to below.

The fact that Social Security has unique tax features provides a recipient with some pretty good planning opportunities. At Decision Tree Financial, we help retirees use the rules in their favor so that they can have more of what they want without the worry.

Talk to one of our advisors about helping your personal finances becoming maximize all the work you put in during your life.

If you need more information before, take a look around the site at more information about Social Security or attend one of our online seminars. You have everything to gain and nothing to lose and you might end up having a little fun along the way!

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