Many of the early questions I am asked by prospective retirees relate to the tax on Social Security. For example, "when I retire is my social security taxable?" Or, "how will receiving Social Security impact my taxes?" The answer to these questions is it depends.
As background, Social Security was first taxable as income in 1984 (Reagan Administration) and last increased in 1993 (Clinton Administration). In other words, the roots of this tax are bipartisan. The purpose of the tax is to provide financial stability to the program.
In tackling this complex issue, you first need to determine whether you will pay any income tax on Social Security. In 1984, 10% of recipients paid income tax on Social Security. Today, estimates show that over 40% of recipients pay.
You will not owe income tax on Social Security if:
• You file as an individual, and your combined income is below $25,000; or
• You file jointly with your spouse, and your combined income is below $32,000.
***Combined income is your adjusted gross income plus nontaxable interest plus one-half of your Social Security benefit.
Important note: If you file separately from your spouse, 85% of your Social Security benefit (the maximum percentage) will be subject to income tax, regardless of your combined income.
When you exceed the combined income threshold, a percentage of your Social Security benefit (up to 85%) is taxable income. However, keep in mind, the actual income tax rate is calculated based on your total taxable income and can range from 10% - 37%.
Let us review an example:
Mary receives retirement income from three sources. Her pension is $80,000 per year. She receives $5,000 annually in municipal bond interest, and her Social Security benefit is $20,000. Mary's adjusted gross income is $97,000. In this instance, Mary's entire pension and 85% of her Social Security benefit, or $17,000, are taxable. The $5,000 municipal bond interest, while not taxable as income, can be a factor in deciding how much of your Social Security benefit is subject to tax. Filing as an individual, with $97,000 adjusted gross income, Mary's highest marginal tax rate is (most-likely) 22%.
Lastly, the income tax we discuss in this post is imposable at the Federal level. Most states, including Ohio, Kentucky, Indiana, and Michigan, do not tax Social Security.
Kommentare