Everyone must make applicable Social Security contributions to income, even those who are working past full retirement age. Working past full retirement age may also increase future Social Security benefits as Social Security contributions continue to be paid.
- Depending on your income, you may pay income tax on part of your Social Security income.
- For 2020, couples filing jointly with a combined income between $32,000 and $44,000 must pay taxes on up to 50% of their benefits. If combined income exceeds $44,000, they will be taxed on up to 85% of their profits.
- For singles, those income limits are between $25,000 and $34,000 for the 50%, and over $34,000 for the 85%.
- Some states will also tax Social Security income separately from what the IRS demands.
Profit Income and Taxation
By continuing to work in accordance with the Social Security Administration limit, which changes each year, current payouts, if any, during the year full retirement age is reached may be reduced.
For example, if full retirement age is reached in July, total benefits earned from January through July must be below the income limit, or Social Security benefits are reduced by $1 for every $3 of income over the limit. which is $50,520 for 2021 and $51,960 for 2021.
That money is with the Social Security Administration and is repaid continuously once the taxpayer no longer works. There is no limit to the amount of earned income in the month that full retirement age is reached when the full benefit amount is paid, no matter how much income is earned.
However, taking Social Security benefits while continuing to work can have the unexpected negative consequence of bumping a taxpayer into a higher tax bracket. Most people forget that a certain percentage of Social Security benefits can be taxed — up to 85% — depending on filing status and combined income, which includes up to half of Social Security benefits.
Some states also tax Social Security benefits. It is possible to withhold taxes from Social Security benefit payments by filling out IRS Form W-4V or requesting the Voluntary Withholding Request Form online. There are currently 13 states in which your Social Security benefits may also be taxable at the state level, at least for some beneficiaries. If you live in one of those states—Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, or West Virginia—check with the relevant state tax agency. Like the federal tax, how these agencies tax Social Security varies by income and other criteria.
How to reduce your Social Security taxes
There are several remedies available to people who are taxed on their Social Security benefits. Perhaps the most obvious solution is to reduce or eliminate the interest and dividends used in the provisional income formula. In both examples shown above, taxpayers would have reduced their Social Security tax if they did not have declared investment revenue on top of their other income.
Therefore, the solution may be to convert reportable investment income into tax-deferred income, such as from an annuity, that will not show up on the 1040 until it is withdrawn. If you have $200,000 in certificates of deposit (CDs), earning 3%, which translates to $6,000 per year, will count as provisional income. But growing that same $200,000 inside an annuity, in which the interest is invested back into the annuity, would effectively yield a reportable interest of $0 when calculating provisional income.
Generally, annuities become taxable income when they are taken as distributions depending on the type of account. Therefore, virtually any investor who isn’t spending all of the interest paid from a CD or other taxable instrument can benefit from transferring at least a portion of their assets to a tax-deferred investment or account. .
Another possible solution may be to do just a little less work, especially if you are at or near the threshold of taxing your benefits. In the first example listed above, if Jim were to transfer his taxable investments into an annuity and earn $1,000 less, he would have virtually no taxable profit. Transferring investments from taxable accounts to a traditional or Roth IRA will serve the same purpose, provided the funding limit is not exceeded.
Steve Stangnelli, CFP®, CRPC®, AEP®, CCFS
Clear View Wealth Advisors LLC, Amesbury, Mass.
As long as you are working and earning income, whether in a self-employed capacity or for an employer, you must contribute to Social Security.
However, whether or not you need to pay taxes on your Social Security benefits depends on your modified adjusted gross income (MAGI). If your MAGI is above a certain threshold for your filing status (such as single or married filing jointly), your benefits will be taxable. Up to 85% of the taxpayer’s Social Security benefits are taxable.