Virtually all Americans believe Social Security is a right to the income they have finally earned after working an entire lifetime, expecting their money paid in full. That’s why many new retirees are surprised to learn that their monthly payments can end up being subjected to IRS scrutiny. Not everyone who receives Social Security has to pay taxes on it, however, those who do they could end up having up to 85% of that money taxed. Let’s examine how Social Security income can become taxable, how many people may end up having to pay back retirement money on April 15th and how to get around it.

Why would you have to pay Social Security tax?

Social Security taxation is easy to explain and understand. If you earn a particular level of income while retired, then you’re required to include a percentage of your benefits when calculating income tax. To determine how much, if any, of your Social Security income, is taxable, you first need to add together all your other current sources of revenue. These sources may include wages, taxable private pensions, and investment earnings. Then add in half of your total Social Security income. Next, you have to consider whether you are filing as either Single/Head of Household/Qualifying Widow(er) or are married and Filing Jointly.

If you are filing as Single (this also includes being a qualified widower or head of household) and earn above $25,000 for the year, then up to 50% of your Social Security can be taxed. Making above $34,000 with the same Single status could jeopardize up to 85% of those benefits. For retirees filing jointly, the penalties are slightly less severe due to raised thresholds in both brackets. For joint filers earning $32,000 at year’s end, 50% of their Social Security is theoretically taxable. Additionally, joint filers have a $10,000 lead over their single counterparts with up to 85% of their benefits subject to tax if they earn $44,000 for the year instead of $34,000. As with most other tax filing circumstances, it is better to file with someone than alone.

How did we get to this point?

These assessment thresholds were first determined and established in 1984; designed at first to only affect a relatively small number of higher-income taxpayers, they did not account for inflation though over time. As a result, the number of Americans affected by these provisions skyrocketed over the decades. By 2013, nearly 30 million taxpayers included Social Security income on their tax returns. The overwhelming majority of those people, over two thirds, found that indeed a percentage of their benefits were taxable.

This finding means that an enormous percentage of money everyday citizens paid into Social Security winds up staying with the federal government. Out of over $550 billion in potential benefits, more than $240 billion of it became taxable income. Breaking those numbers down further reveals that 44% of American taxpayers are subject to benefit taxation.

How can I fight back?

Despite this predicament for most Americans, there are ways to fight back against paying these taxes. First, find and cultivate tax-free income available to you in retirement. Unfortunately, municipal bond income won’t work because the IRS requires it counted when calculating overall income for taxation. However, Roth IRA distribution is not counted; thus, it does not apply towards the thresholds.

Second, consider possibly deferring your benefits to avoid taxation. For example, accepting Social Security income while still actively employed can be helpful, it also increases the chances that those benefits get taxed. If filing jointly then you should also understand that even if you retired but your spouse is still working, your combined revenue could still push past the income thresholds. Sometimes, waiting to claim benefits until much later can protect that money because other sources have dried up. As a result, the requirements may not be met, and benefits remain intact. Along those same lines, knowing when to withdraw from traditional IRAs and 401(k)s can affect your taxable income, which in turn will determine how much Social Security is touched.

Finally, look for methods to aid your income in years where you do not meet the threshold. For example, some retirees will wait until reaching 70 ½, the maximum allowable age, before finally making 401(k) and IRA withdrawals. However, doing so will trigger minimum distributions that are almost certain to trigger Social Security taxation. Instead of taking larger payouts all at once, you can spread those withdrawals out over time, which will allow you to enjoy them while protecting your benefits from getting taxed.

Social Security tax is an unwelcome reality many retirees are forced to deal with unexpectedly. By knowing the mechanisms that trigger it, though, you can take steps to either minimize the damage or avoid it altogether. Now that you have an idea of how Social Security can affect your tax return, feel free to contact our tax department to look over your current returns and see if you’re currently accounting for your benefits properly. It not, we can help you fix that without problem.