If you’re wondering how your Social Security benefits are taxed, you’re not alone. We’ve outlined four important facts you should know about Social Security benefits taxation and what, if anything, you can do to reduce your tax burden.
1. Social Security tax thresholds are not adjusted for inflation.
The 2023 cost-of-living adjustment (COLA) of 8.7% for Social Security benefits was a boon for many retirees feeling the effects of sustained high inflation. The boost in benefits may even enable you to reduce how much you may need to withdraw from your investment portfolio, which can be especially beneficial in down markets. However, it’s important to note that even though your benefits increased, the combined income threshold for how much your benefits will be taxed did not. So, while this boost in benefits can help better meet the growing cost of day-to-day needs, the COLA increase may mean more of your benefits will be taxed.
2. Certain states also tax Social Security benefits.
In addition to paying federal taxes on your Social Security benefits, you may also need to pay state taxes depending on where you live. Several states may tax Social Security benefits. If you live in one of these states, and depending on your adjusted gross income, you may need to factor this additional tax liability into your retirement income strategy.
3. Withholding benefits can help reduce your year-end tax bill.
To help avoid a bigger-than-expected tax bill or an underpayment penalty, you can file IRS Form W-4V with the Social Security Administration and request to have 7%, 10%, 12% or 22% of your monthly benefits withheld. Fortunately, you are not locked into one rate forever. You can change it, if you like, based on changes in your financial picture.
4. Certain retirement accounts do not count toward your combined income.
The percentage you take out from some of your retirement accounts each year — your annual withdrawal rate — can affect the amount of your Social Security benefits that may be taxed. However, not all funds from these accounts will be included in your combined income.
For instance, withdrawals from a Roth IRA won’t be taxable, provided you’ve held your account at least five years and you didn’t tap into it before age 59½. If you don’t have a Roth IRA, you can convert your traditional IRA to a Roth IRA to gain access to tax-free distributions in the future. However, you’ll have to pay taxes at the time when you convert your funds.
Taxes are not the “be-all and end-all”
Though it may be tempting, reducing your tax burden as much as possible shouldn’t be the only consideration when it comes to funding your retirement. Your Edward Jones financial advisor and qualified tax professional can help you determine the best overall retirement income strategy for you.