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Are Social Security Benefits Tax-Free? - Not Exactly

It's a common misconception to believe that Social Security benefits are tax-free. While that is the case for some people, for many Americans, some or even most of their Social Security income will be taxable. When does Social Security become taxable? Read further to find out. 


When are Social Security benefits tax-free? 

The threshold for tax-free benefits are quite low. Your total income, (which includes Social Security benefits, pensions, IRA distributions, capital gains, etc.) must be below $25,000 for individuals and $32,000 for those married filing jointly.1 Not exactly a large income, especially for higher cost of living states like Massachusetts and New Hampshire! 

 

How much of Social Security is taxable? 

This is also dependent on how much income you have. Up to 85% of your Social Security benefits can be taxable for individuals with over $34k of income and joint filers over $44k.1 As an example, if a married couple has $50k of income and receives $1,000 a month in Social Security benefits ($12,000 annually), 85% of the $12,000 will be taxable to them ($10,200). If they're in the 12% tax bracket, the tax on their Social Security would be about $1,225.  

To make matters more complicated, benefits are 50% taxable if your total income falls between non-taxable, and 85% taxable. However, regardless of the amount of income you have, at the time of this writing, your benefits will not be over 85% taxable.  

 

Tax Traps to look for 

The tricky part with Social Security benefits is that the more income you have, the more it becomes taxable (up to 85%). What this means, is that it is possible for those in a low tax bracket to pay a high percentage on additional income as more and more of their social security benefits become taxable. How might you get additional income? Taking money from your IRA is a common way that retirees can increase their total income. Even realizing capital gains from a taxable investment account can have a dramatic impact on Social Security taxation if you're not being careful. This article from Nerd Wallet has a great chart to show how this can happen in practice 

Calculating what impact additional income has on your Social Security benefits can be tricky. If your financial advisor or tax professional uses tax planning software, this is normally the best way to estimate what the impact might be. 

 

What about state taxes? 

Another wrinkle when considering tax impact is whether your state will also tax these benefits. Luckily for those in New England, New Hampshire doesn't have a traditional income tax (just on dividends and interest), and Massachusetts does not tax Social Security income.2 However, some states do tax Social Security, so it's important to take this into consideration when doing tax planning on your income. 

 

Wrap Up: 

Social Security taxes are more complex than most people realize. They can be particularly treacherous if you normally have a low income but generate additional income in a year. If you're claiming Social Security, stop and think twice before pulling additional money out of your IRA. You might end up paying more taxes than you realize.  


1 https://www.ssa.gov/planners/taxes.html 

2 https://www.mass.gov/info-details/massachusetts-tax-information-for-seniors-and-retirees