Social benefits can make retirement much more affordable, especially if your retirement savings fall short. The average retiree collects over $ 1,600 a month in benefits, according to the Social Security Administration, which can go a long way in retirement.
However, there is a sneaky expense that can take a bite out of your benefits. And if you are not prepared for it, it can throw off your budget when you retire.
How taxes affect your social security
Unfortunately, even when you retire, you may not be able to get away with it. Your social security benefits may be subject to both state and federal income taxes, and it is wise to prepare for them now so that they do not surprise you along the way.
State taxes will depend on where you live, as each state has different rules for whether benefits are taxed.
The good news is that 38 states do not tax social security at all. The 12 that do include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont and West Virginia. (North Dakota also taxed previous benefits, but from 2021 has excluded social security from taxation.)
Whether you owe federal taxes will depend on a factor called your “combined income.” This is your adjusted gross income (e.g. 401 (k) payments) plus half of your annual social security amount.
|Percentage of your benefits subject to federal taxes||Total income for individuals||Total income for married couples applying jointly|
|0%||Less than $ 25,000 a year||Less than $ 32,000 a year|
|Up to 50%||$ 25,000 to $ 34,000 per year||$ 32,000 to $ 44,000 per year|
|Up to 85%||More than $ 34,000 a year||More than $ 44,000 a year|
Fortunately, you do not pay federal tax on more than 85% of your benefit amount, regardless of your income. However, the only way to avoid federal taxes is if your total income is less than $ 25,000 a year (or $ 32,000 a year for married couples).
How to reduce your social security taxes
In many cases, social security taxes are simply something pensioners need to live with and prepare for. Sometimes, though, there are steps you can take to avoid them.
If you live in a state that taxes social security, consider whether it is worth moving to a more tax-friendly state. Of course, there are plenty of other factors to think about before you move. But in some cases, moving can help you save a lot of money.
To contribute to one Roth IRA could also reduce your federal taxes because Roth IRA payments do not count toward your total income. If the majority of your retirement income is from this type of account, you could potentially reduce your total income enough to lower or even eliminate federal taxes on your benefits.
Taxes can have a greater impact on your social benefits than you might think. But with the right strategy, you can retire as prepared as possible.
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