Social security recipients may get an unpleasant surprise when they see that their benefits are taxed more than usual this year.
Social security is taxed based on provisional income and a designated threshold, and the more money a retiree brings in, the more likely they are to pay tax on these benefits. Although Americans continued to live through a pandemic in 2021, there are a few reasons why they may be responsible for a higher tax bill, including retiring that year while receiving benefits or delaying required minimum distributions in the previous year. .
Either way, not everyone is prepared, said Mary Johnson, an analyst at the Senior Citizens League.
Retirees may think, because they no longer earn a salary, that they would not be subject to taxation on their benefits, said Michelle Gessner, a certified financial planner and founder of Gessner Wealth Strategies.
“Retirees forget that even though they may not have earned income upon retirement, they will have taxable income that includes social security benefits, interest income, retirement income and the distributions they take from their IRAs,” Gessner said. “When all that counts, they are often shocked to see that they are not in the lower tax bracket that they had expected – even without earned income.”
About 40% of social security recipients pay taxes on their services, the Social Security Administration said.
Provisional income is half of a recipient’s social benefits plus adjusted gross income and income from tax-free interest (such as municipal bonds).
There are limits to how much a person can receive without paying tax on benefits – individuals earning between $ 25,000 and $ 34,000 can pay income tax on up to half of their benefits and those earning more than $ 34,000 , can see 85% of their benefits taxable. The thresholds for married filing by common taxpayers are $ 32,000 to $ 44,000 for up to 50% taxed and more than $ 44,000 for 85%.
Taxpayers who are married but file separately will “likely” pay tax on benefits, Social Security Administration said.
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The National Board of Health and Welfare Report expects about $ 10.6 billion more in tax revenue this year, though that is only an intermediate estimate and the numbers may change. According to the report, taxation of benefits would raise $ 45.1 billion in 2022, up from $ 34.5 in 2021.
Retirees could expect to pay more in Social Security taxes if they delayed their required minimum distributions by 2020. As part of a federal emergency relief package, Americans were allowed to give up their RMDs in 2020, which is the amount individuals will have to withdraw from their pension accounts each year if they have not already started deducting these balances by the age of 72. If they delayed their 2020 RMD, that means they probably would have had to withdraw more money by 2021, which could put them at risk of exceeding the threshold.
Many workers also retired in 2021, Johnson said. Because wages are part of the provisional income, these incomes could work against their best interests in terms of taxes if they started requiring social security the same year.
There may not be much retirees can do right now to lower their tax liability this tax season, as 2021 is behind us, but they may begin to prepare for the 2023 tax season. “Early planning is the key,” said Rose Swanger, a certified financial planner and principal of Advise Financial. Ideally, workers would start thinking about their sources of income upon retirement five to 10 years in advance so they can have a better understanding of what they will pay in social security taxes and medical premiums, she said.
Retirees may also want to choose a qualified charity distribution or QCD if they are financially comfortable doing so, Swanger said. With QCDs, retirees give their required minimum distributions to charities, which then preclude deduction from taxable income.
Roth conversions are another option, and withdrawals from Roth 401 (k) plans or IRAs are not considered part of preliminary income calculations, Gessner said. Because individuals have to pay tax on the amount they convert from a traditional account to a Roth account, both workers and retirees should work with a qualified financial planner or tax intermediary who can determine how much can be converted without pushing the person into a higher tax framework. These converted dollars will then continue to grow tax-free.
Some retirees may also ask the Social Security Administration to withhold some of their benefits, Johnson said.
The cost of living adjustment for social security was only 1.3% in 2021, so it probably would not have brought benefits into the taxable area. But retirees should pay close attention to what income they will receive in 2022 and how much they can reasonably expect to pay in taxes next year. COLA for 2022 was 5.9% – “it’s going to affect us next tax season,” Johnson said. “We have to plan carefully, and we have to do it now.”