As part of retirement planning, you are likely watching your Social Security statements closely from year to year in anticipation of the estimated payouts displayed. However, some people may overlook the tax liability. Social Security may be subject to income tax, but it may depend on your circumstances.
Social Security benefits have been subject to federal income tax since 1984, long after the first disbursements were issued in 1940. Between 1940 and 1984, these benefits were exempt. Then, policymakers reevaluated the tax exemption based on the fact that other forms of retirement such as pensions were subject to tax. What has not changed are the income amount thresholds, which means that as wages have risen, the proportion of people liable for taxes have increased accordingly.
Taxable Portion of Income
The Social Security Administration website displays a table showing the taxable portion of income for Social Security beneficiaries by income filing status (single or married filing jointly) corresponding to modified adjusted gross income (AGI). Federal rulings approved in 1983 and 1993 established the taxable portion of Social Security benefits based on AGI. As a result, your tax liability may be applied to either 50% or 85% of your Social Security benefit.
Do not be alarmed in mistaking the tax rate for the amount subject to tax. As an example, a married couple filing jointly with an AGI under $32,000 may not be subject to tax on their Social Security benefit. Between $32,000 and $44,000, a couple may expect 50% of their benefit to be taxed. If a couple’s AGI exceeds $44,000, they may expect 85% of their benefit to be taxed. The actual tax liability is based on each individual’s or couple’s marginal income tax rate.
How Taxes are Paid
The government provides options for the method of payment. Completing Form W-4V (Voluntary Withholding Request) enables you to choose the withholding amount: 7%, 10%, 12% or 22% of the monthly benefit. Another path you can take is disbursing estimated payments to the government on a quarterly basis, a process familiar to self-employed individuals. The third choice, which is likely the easiest for most, is to allow the Social Security Administration to calculate and withhold taxes from the payments. Of course, the methodology is a personal decision, and it would be wise to first discuss with a professional accountant.
The tax information referenced above pertains to federal taxes. Additionally, there are 13 states that collect tax on Social Security payments. Taxes imposed by Minnesota, North Dakota, Vermont and West Virginia abide by federal rules. Partial taxes, taking into account income and age, are collected in Colorado, Connecticut, Kansas, Missouri, Montana, Nebraska, New Mexico, Rhode Island and Utah. However, AARP cautions that you may not be home free even if you live in one of the other 37 states because taxes may be imposed on other types of retirement payments such as pensions or distributions from 401K plans. Contact your state tax authority to determine how this impacts you individually.
In addition to tax withholding, remember that Medicare payments are typically deducted from benefit checks. The 2019 Medicare Part B premium jumped slightly to $135.50, an increase from the 2018 premium of $134. Medicare Part A is usually premium-free if you worked for a certain number of quarters while working. Check the Medicare website to confirm your eligibility as well as an explanation of what is included in each part.
Social Security and Medicare information can be difficult to navigate. For your peace of mind, consult with your personal tax and financial advisers for support in making these important decisions.