Depending on the year of birth, a person may become eligible for social security benefits as soon as they reach the age of 62. However, many people wait longer to claim this benefit to ensure that they claim a larger amount.
The question many people want answers to is whether or not their social security benefits are taxable by the Internal Revenue Service (IRS), the answer is however not clear cut as it depends on a number of factors including the amount that is made on the side as additional income by the person filing the taxes.
Tax Shark, a tax firm, also notes that many states assess tax based on the benefits.
Determining Whether Social Security Benefits Are Taxable
It is a standard rule that seniors who depend solely on social security are not required by the government and IRS to pay federal income taxes on the benefits that they subsist on. However, the rule changes as soon as seniors begin to earn a little extra income on the side.
Seniors who are earning on the side, even tax-exempt interest income, are required to add one-half of their annual social security benefits to their income and then compare the outcome to the range that has been prescribed by the IRS.
If the total amount earned is over the IRS threshold, then some of the Social Security Benefits becomes taxable.
For the year 2020, the IRS set a range of $25,000 for singles and $32,000 for couples who are filing jointly. It is important to note that married couples who are living together but choose to file separately will enjoy a $0 threshold which means that they are required to pay taxes on their social security benefits irrespective of other income sources.
To ensure that you are doing your calculations the right way, you need to be aware of the formula to use. The formula for calculating your combined income involves;
Adjusted gross income + non-taxable interest + ½ of social security benefits.
Other income earned – included in the adjusted gross income, can be from any job held by the person filing the taxes including 401(k) withdrawals.
For a clearer understanding, social security benefits are taxed in;
– Seniors are required to pay up to 50% of Social Security benefits if they are earning incomes within the range of $25,000 to $34,000 for singles and $32,000 to $44,000 for jointly filed taxes by married couples.
– Seniors will be required to pay up to 85% of their Social Security benefits in taxes if they are earning an income over $34,000 for singles and $44,000 for married couples.
Taxable Social Benefits
The amount of tax an individual or a couple is paid depends on their level of income. For context, this is determined by deducting the gross income from the IRS base amount.
In addition to this, residents of 13 states in the United States are required to pay state tax on social security benefits based on certain circumstances. These states include Connecticut, New Mexico, Colorado, Nebraska, Minnesota, Kansas, Montana, Missouri, Utah, North Dakota, Vermont, West Virginia, and Rhode Island.
How To Avoid Paying Taxes On Social Security Income
– Keep some of your retirement income in Roth Accounts
One of the ways to ensure that you are not paying tax on your social security income is to ensure that you open an account with Roth. Whether a Roth IRA or a Roth 401(k), you can rest assured that these contributions are made after-tax and it means that you will be qualified to withdraw the money at will without having to worry about paying taxes on it.
Rest assured that Roth payout won’t diminish the income that is taxable and this allows you to stay within the bracket that has been set by the IRS.
– Withdrawal of taxable income prior to retirement
One other way to avoid paying taxes on your social security benefits is to ensure that you withdraw all table income while still actively in service.
By withdrawing funds earlier or by taking distributions from your 401(k) and IRS, you get to enjoy a penalty-free action after 59½.
Also note that at age 72, you will be required to take minimum distributions from the IRA and 401(k) accounts that you hold and operate.
– Purchase of an Annuity contract
A deferred annuity that is supported with funds from an investment made into an IRA or qualified retirement plan can be referred to as a Qualified Longevity Annuity Contract (QLAC). This can save you from paying taxes on your social security benefits. To learn more about this, speak to your tax expert.