Like most people in America today, you have spent all of your life paying into Social Security, but did you know that up to 85% of your benefits may be ate up by tax demands from the government? In this case, tax planning can help to ease the burden.
How hard the taxes on benefits hit you and your family will be determined by your marital status and your income. First, you will need to figure out your modified adjusted gross income. This includes your non-Social Security sources of taxable income. These include any wages you have earned, pensions, dividends and interest. You will also need to factor in any tax-exempt interest and other exclusions from your income. One thing that will not help with this calculation is itemized deductions.
If your provisional income surpasses the base amount, you will be paying a federal tax on your benefits. This is the case for many retirees who have taken the time to create investment income. These can take the form of rental income, a pension or any stocks that you currently own.
The percentage of your benefits that are able to be taxed will be determined by your income. When it comes to percentages, up to 50% of benefits are taxable when your provisional income is between $32,000 $44,000 for those who are married and filing jointly and for single filers $25,000-$34,000. If your provisional income is above $44,000 for singles and $34,000 for married people then up to 85% of your Social Security benefits will be taxable.
Let's imagine that you are married and filing jointly and you make your $42,000 provisional income which includes half of your Social Security benefits which happens to be $12,000. This income would exceed the $32,000 base amount by $10,000. In this case, the benefits would be $6,000, half of the excess income over the base amount of $5,000 --whichever is of the lesser value. In this scenario, you would include $5,000 of the benefits in your taxable income. The tax on these benefits would be $750, a 15% tax rate.
As you move forward in reducing your taxes, remember that worksheets in IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits, will help you to calculate the taxes that you will owe accurately. You can also check in with your state's tax department to determine if taxes even come in to play with benefits in your state.
Of course like everyone else you want to lower the tax on your benefits and to do so you have to reduce your overall taxable income. Social Security taxation reduction can become easy if you fall between the borderline of the %50 and 85% income wise. The first rule is always to try to avoid peaks and valleys in income. If you have been beneath the 85% income threshold, a nice profit from a stock sale could boost up your taxable income.
In this case, you might think about accelerating your income into just one year or even pushing off income to another year altogether. You can also reduce taxable income by boosting pretax IRA and 401(k) contributing.
While you can avoid some of your tax expenses, a one-time tax blow could be well worth it. Remember that any withdrawals from a traditional IRA and 401(k) are going to be counted as taxable income. If you convert it, you may reduce the tax blow on your future benefits making it a win/win either way.
