There’s one hidden price that could eat into your advantages
Saving for retirement is difficult, and Social Security payments can help bridge the gap between what you have saved and what you need to live comfortably in your golden years.
However, there is one hidden cost that could reduce your Social Security income. And if you live in one of the 12 states, you might not get as much money each month as you expect.
What effect do taxes have on your Social Security?
You may owe Uncle Sam a percentage of your salary even after you retire. Not only are withdrawals from 401(k) and regular IRAs taxed, but so are Social Security payouts.
You may be responsible for both state and federal taxes on your benefits. Your state taxes will vary depending on where you live, but the good news is that Social Security benefits are not taxed in the majority of states.
The following states tax your monthly payments:
|Rhode Island||Utah||Vermont||West Virginia|
You’re not out of the woods yet if you live in a state that doesn’t tax Social Security. You may owe federal taxes on your benefits regardless of where you live.
Your combined income will be used to calculate your federal taxes. Half of your annual benefit plus your adjusted gross income equals this amount.
For example, if you receive $20,000 per year from Social Security and $30,000 per year from your 401(k), your total income would be $10,000 plus $30,000, or $40,000.
Depending on your combined income, the following percentage of your benefits may be liable to federal taxes:
|Percentage of Your Benefits Subject to Federal Taxes||Combined Income for Individuals||Combined Income for Married Couples Filing Jointly|
|0%||Less than $25,000 per year||Less than $32,000 per 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 per year||More than $44,000 per year|
The good news is that you can completely avoid federal taxes. However, because the income restrictions are so low, you’ll need a joint annual income of less than $25,000 (or $32,000 if married) to avoid paying federal taxes on your benefits.
How to lower your retirement taxes
In many circumstances, taxes are an unavoidable cost that workers must budget for when they retire. However, there is one method for potentially lowering your taxes: contributing to a Roth IRA.
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Withdrawals from a Roth IRA are already tax-free, but this type of account can also help you avoid paying taxes on your Social Security benefits. Withdrawals from a Roth IRA are not included in your total income.
If you obtain the majority of your income from a Roth account, you may be able to avoid paying federal taxes entirely.
For example, if your yearly Social Security payment is $20,000 and you withdraw $30,000 per year from a 401(k), your combined income is $40,000 per year, meaning federal taxes will apply to up to 85% of your benefits.
Assume you continue to get $20,000 per year from Social Security, but instead of a 401(k), you withdraw $30,000 per year from a Roth IRA (k). In this instance, your joint annual income is only $10,000, and you pay no federal taxes on your benefits.
Getting the Most Out of Social Security
It’s understandable that not everyone will be able to contribute to a Roth IRA. You might be better off sticking with whatever retirement account you have if all of your retirement funds are in another form of account or if you’re earning matching contributions through a 401(k). However, knowing your options is always a good thing.
For most individuals, taxes are an unavoidable part of life, so it’s a good idea to start planning for them early. You may avoid any Social Security shocks in retirement by knowing the taxes you may owe and putting them into your budget.