“You're all revved up to retire from your job, and your co-workers have planned a surprise retirement party for you. But did you know that a big surprise for many retirees is that their Social Security benefits and retirement investments are subject to taxes?”
If you're working part-time or withdrawing from your investments, taxes are just one of the reasons you should think about delaying your Social Security benefits. A recent Vanguard article titled “Wait . . . I'll owe taxes on Social Security income?” says that whether you'll owe taxes on your Social Security income is determined by the provisional income formula. That calculation is as follows:
Provisional income (PI) = adjusted gross income (AGI) + tax-exempt bond interest + 50% of your Social Security benefits.
If your PI for the year is above these thresholds, some of your benefits may be taxable. The amount of Social Security income that's taxable is the least of the following three calculations:
- 85% of Social Security benefits.
- 50% of Social Security benefits + 85% of PI over $34,000 (single) or $44,000 (married, filing jointly.
- 50% of PI over $25,000 (single) or $32,000 (married, filing jointly) + 35% of PI over $34,000 (single) or $44,000 (married, filing jointly).
Many states don't tax Social Security benefits, but those that do either follow the same federal PI rules, or they have special rules and income thresholds to determine what's taxable. These four states use the federal PI formula: Minnesota, North Dakota, Vermont, and West Virginia. The taxable portion of Social Security for these states is the same as the federal amount. Nine states have special rules and income thresholds. They are Colorado, Connecticut, Kansas, Missouri, Montana, Nebraska, New Mexico, Rhode Island, and Utah. Most use the federal AGI.
Remember that your Social Security benefit increases the longer you wait to begin taking it, up to age 70. For some folks, especially those who rely on Social Security more than investment income, delaying benefits could help ease their tax burden. However, for those at higher income levels—where up to 85% of Social Security is taxed—delaying benefits may not affect the taxability of their Social Security benefits. However, it is an element in tax planning when coordinated with other retirement resources.
Although taxes are important, it’s not the only factor when deciding when to start taking Social Security. When it comes to your retirement strategy, look at your overall income level, if you plan to leave survivor benefits to a spouse, the tax status of the types of accounts or investments you have, your overall health and any plans you may have for leaving an inheritance. Creating a sound strategy can be difficult without professional help, so consult an experienced estate planning attorney.
Reference: Vanguard (November 30, 2016) “Wait . . . I'll owe taxes on Social Security income?”