You might be wondering: Is Social Security taxable? The answer is yes, but you may not realize that you have the power to mitigate the effects that taxes have on your income. That's because a crucial part of the application process – withholding federal taxes – is often ignored. If you skip the section on the Form W-4V that asks how much money, if any, you want withheld for federal income taxes, you could be unpleasantly surprised when tax filing time comes around.
If your annual income is above a certain amount when you're receiving Social Security, you may owe federal income taxes. Because the income threshold is relatively low, it’s likely that some of your benefits will be taxed. If you’re married and file taxes jointly, up to 85 percent of your Social Security benefits will be taxable if your combined income is more than $44,000. If you’re a single filer, that figure is $34,000. (“Combined” income includes your adjusted gross income, nontaxable interest, and one-half of your annual Social Security benefits.)
To help avoid a bigger-than-expected tax bill or an underpayment penalty, you can file Form W-4V with the Social Security Administration and request to have 7, 10, 12 or 22 percent of your monthly benefits withheld.
It’s important to choose the right withholding amount – but it’s even more important to understand how your Social Security benefits fit into your overall retirement income plan. Consider this: The percentage you take out from some of your retirement accounts each year – your annual withdrawal rate – can affect the percentage of your Social Security benefits to be taxed. However, not all funds from these accounts will be included in your taxable income. Perhaps most importantly, withdrawals from a Roth IRA won’t be taxable, provided you’ve had your account at least five years and you don’t tap into it until you’re at least 59½. Health savings account (HSAs) withdrawals used for qualified health expenses also won’t count toward your taxable income.
And, generally speaking, the larger your retirement accounts, the less dependent you’ll be on Social Security, which could allow you to delay taking your benefits. You can start receiving payments as early as 62, but they’ll be significantly bigger if you wait until your “full” retirement age, which will likely be between 66 and 67, and they’ll “max out” when you reach 70. Still, in deciding when to start collecting Social Security, taxes are generally less important than other factors, such as your anticipated life expectancy, your employment situation, your spending needs and your spouse’s income.
In any case, when you do start taking Social Security, consult with a tax advisor to determine how much you should have withheld. You’re not locked into one rate forever – you can change it every year, if you like, based on changes in your financial picture. But, as with every decision that affects your retirement income, you’ll want to make the right choice.