Taxes on Social Security: What You Need to Know

Will your Social Security benefits be taxed and what implications are there for federal employees and retirees?

Let’s tackle a topic that concerns many retirees: How–if at all–are Social Security benefits taxed? 

This issue sparks a lot of confusion, with some people assuming Social Security benefits are always tax-free. 

Unfortunately, that’s not the case. Let’s break down the details so that you can understand how your Social Security income may impact your tax situation.

We’ll start with the most common question (and misconception) about Social Security taxation…

Isn’t Social Security Tax-Free for Everyone?

The short answer is no, Social Security payments are not tax-free for everyone. Some people don’t pay taxes on their benefits, but that’s not true for all.

Whether your Social Security benefits are taxed depends on your income in retirement (and where it comes from). Let’s take a closer look at the requirements.

For single filers, if your income is $25,000 or less, or if you’re married and filing jointly with a combined income of $32,000 or less, your Social Security benefits won’t be taxed.

Understanding Combined Income

Combined income is a crucial factor in determining Social Security taxation. It includes your adjusted gross income (AGI), non-taxable interest, and half of your Social Security benefits. Remember that Roth IRA withdrawals are not counted, but municipal bond interest is.

If your combined income falls between $25,000 and $34,000 for single filers or between $32,000 and $44,000 for married filing jointly, 50% of your Social Security benefits will be subject to taxation.

Make sure you understand this critical distinction. Your Social Security benefits will not be taxed at a 50% rate. Rather, 50% of your Social Security income will be subject to taxation at whatever your tax bracket happens to be. 

Now, if your income exceeds $34,000 for single filers or $44,000 for married filing jointly, a whopping 85% of your Social Security benefits will be taxed at your applicable tax rate.

Implications for Federal Employees and Retirees

If you’re a federal employee or retiree, you might find it challenging to stay below Social Security’s taxation thresholds. When you consider your federal pension along with half of your Social Security and your spouse’s Social Security (if applicable), it’s easy to surpass these limits.

For instance, the average federal pension is around $1,800 per month, and the average Social Security benefit for a retired worker is $1,828 per month. If you add a spousal benefit (around $900 per month), you’re looking at an annual income of approximately $54,000. This exceeds the $44,000 limit, thereby resulting in 85% of your Social Security benefits being subject to taxation.

Inflation and Taxation Thresholds

Interestingly, these taxation thresholds are not adjusted for inflation, unlike many other IRS rules. Originally set in the 1980s when $44,000 annually was considered a high income, these thresholds have remained static. In today’s context, $44,000 is not as high as it once was, meaning more retirees may be subject to this tax.

The Bipartisan History of Social Security Taxation

This is probably a good place to mention that Social Security taxation isn’t a partisan issue. The 50% tax rate was introduced during the Reagan era with a Democratic Congress, and the 85% rate came into play during Bill Clinton’s presidency–with a Republican Congress! So, no matter your political allegiance, we all share some responsibility for these tax rules.

Planning Techniques to Mitigate Taxation

For those who aren’t federal employees, there may be planning strategies you can use to lower your combined income and minimize Social Security taxation. If, for example, you don’t have a pension and you rely on Social Security and asset distributions, by utilizing the tax advantages of Roth IRAs, you can reduce your taxable income.

However, if you’re a federal retiree with both a substantial pension and Social Security benefits, you may find it challenging to avoid taxation. In such cases, it’s essential to consider when to begin claiming Social Security benefits. That’s where an experienced financial advisor can help you figure out a plan for minimizing your tax burden.

Let’s address this issue now!

Understanding how Social Security benefits are taxed is crucial for planning your retirement finances. While some individuals can take steps to reduce their tax liability, federal retirees often face challenges in staying below the taxation thresholds. 

If you’re one of those who is contemplating the optimal time to start claiming your Social Security benefits, consult your financial advisor.

About the Author

Mel Stubbs is a Financial Planner and educator at Christy Capital who works with federal employees all over the country, teaching them how their retirement system works and how to plan for retirement using their available benefits.