Los Angeles, California – A new bill in Congress seeks to remove federal taxation of Social Security benefits for retirees, potentially boosting their net income. While the You’ve Earned It Act is still pending, it’s crucial for retirees to understand how their Social Security benefits are taxed at the federal level.
Contrary to popular belief, Social Security benefits are not entirely tax-free. In fact, retirees who have a well-funded retirement income plan may be subject to income taxes in retirement. The amount of retirement income greatly affects the taxes owed, with higher income resulting in higher taxes.
Approximately 60% of retirees are not required to pay federal income taxes on their Social Security benefits, leading many to mistakenly believe that these benefits are tax-free. However, the reality is that a majority of retirees are living on a low income, or even in poverty.
The good news is that Social Security income is taxed at a lower rate compared to other forms of retirement income. At least 15% of Social Security benefits are tax-free, regardless of the retiree’s total income.
Surviving solely on Social Security benefits in retirement is challenging for most Americans, as the average annual benefit in 2023 was only $20,469. Additional factors such as other sources of income, such as 401(k) distributions, wages, dividends, and rental income, also impact the taxation of Social Security benefits.
Retirees should pay attention to their provisional income, which includes adjusted gross income, nontaxable interest, and 50% of their Social Security benefits. Depending on their filing status and their provisional income, retirees may owe taxes on 50% or even 85% of their Social Security benefits.
To avoid being surprised by a significant tax bill, retirees can use their Social Security Earnings Statement to anticipate their tax liability and make estimated quarterly tax payments. They also have the option to have federal taxes withheld from their Social Security checks.
Understanding the taxation rules of Social Security benefits is essential for retirees, as it can impact their overall financial planning and standard of living in retirement.