By Melissa Horton
A:Nearly 90% of individuals over age 65 rely on Social Security income to pay for a large portion of living expenses throughout their retirement years. The federal government makes this benefit available to those who have worked and contributed to the system for a certain number of years, but the total monthly benefit varies from person to person. Although Social Security is an inevitable part of most individuals’ retirement planning, retirees may not be fully aware of how and when those benefits are taxed.
When Social Security Is Not Taxable
For retirees who receive Social Security income with little to no supplemental influx of cash, either from retirement plan distributions or other earnings, most likely those benefits are not taxable. The average benefit received is just under $1,300 each month, totaling $15,600 annually, and benefits are only taxable when combined income exceeds $25,000 for single retirees or $32,000 for couples filing joint tax returns. Individuals who are able to sustain the type of lifestyle they need or want on that level of income do not pay taxes on their Social Security benefits.
Taxable Social Security Income
For Social Security benefits to be taxable, individuals must have income above the threshold. This is based on total combined income, calculated as an individual’s adjusted gross income plus nontaxable interest earnings and half of his or her Social Security benefit. If combined income for a single individual is above $25,000 but below $34,000, or above $32,000 but below $44,000 for married couples, 50% of Social Security benefits are taxed. Combined income above these maximum amounts results in benefits taxed up to 85%. At this time, there is no income level that creates a situation where Social Security benefits are 100% taxable for retirees.
Avoiding Tax on Benefits
The simplest way to keep Social Security income free from income tax is to keep total combined income low; however, most retirees are not able to live on the average monthly benefit of $1,300 without supplementing it from investments or savings. Individuals receiving Social Security benefits can get creative to avoid reaching or exceeding the relatively low combined income limits. Instead of taking distributions from a traditional IRA or other pre-tax retirement savings plans, such as an employer sponsored 401(k) or 403(b), distributions from a Roth IRA may provide the supplemental income necessary to meet living expenses without affecting the combined income calculation. Because Roth IRA distributions are made with post-tax dollars, withdrawals are tax-free in retirement and therefore do not increase total income for Social Security taxes. A similar effect can be achieved by withdrawing from conventional savings or money market accounts in lieu of pretax investments.
If Roth IRA or savings assets are not available during retirement, retirees may want to consider lowering living expenses to stay below the combined income limits. Paying off a mortgage balance or downsizing to a smaller home prior to receiving Social Security income may considerably reduce the need for supplemental income throughout retirement. Although Social Security income is not fully taxable at any time, retirees need to be aware that benefits are subject to income tax under some circumstances and they must plan to reduce other sources of income if necessary.
Read more: How can I avoid paying taxes on my Social Security income? | Investopedia http://www.investopedia.com/ask/answers/013015/how-can-i-avoid-paying-taxes-my-social-security-income.asp#ixzz4SMmxiSgx
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