How Social Security Benefits Can End Up Taxed by as Much as 85%

Many retirees expect their Social Security payments to be free from taxes after years of payroll contributions, but an easy-to-activate income rule can send a large share of those benefits to the IRS.

Most people qualify for Social Security in retirement by working and paying payroll taxes. Some benefits, such as spousal benefits, can be received without a full earnings record. Still, for most people, Social Security is earned through years of contributions.

That can create the impression that once benefits begin, they arrive tax-free. In reality, that is not always the case.

Depending on your overall income, as much as 85% of your Social Security benefits may be taxable. Understanding the rules can help you avoid surprises.

Why Social Security benefits are taxed

Social Security benefits first became taxable in 1983, when lawmakers sought to treat them more like other retirement income, including private pensions, which are generally taxed.

There is also a funding reason. While payroll taxes provide most of Social Security’s revenue, the program also collects money from taxes on benefits. That may be frustrating for retirees, but it helps support the system.

When Social Security becomes taxable

Taxes on Social Security are not automatic. They depend on your provisional income, which is calculated by adding adjusted gross income, tax-exempt interest, and 50% of your annual Social Security benefits.

For single filers, provisional income between $25,000 and $34,000 can make up to 50% of benefits taxable. For married couples filing jointly, that range is $32,000 to $44,000.

Once provisional income rises above $34,000 for single filers, as much as 85% of benefits may be taxed. For married couples filing jointly, that 85% threshold begins above $44,000.

These limits are low and easy to hit because they have not been adjusted for inflation in decades.

That lack of change is deliberate. Lawmakers have been reluctant to raise the thresholds because Social Security needs revenue to remain financially stable.

Ways to reduce the tax hit

If you would rather not pay taxes on your Social Security benefits, there are some steps that may help reduce the impact. One option is to build retirement savings in a Roth IRA or Roth 401(k), since qualified Roth withdrawals are tax-free and do not count toward provisional income.

If that was not part of your planning earlier, a Roth conversion before you claim Social Security may help. Withdrawals from Roth accounts generally do not increase provisional income.

Even so, Roth conversions can create a taxable event, so they need to be handled carefully. A large conversion could create a significant tax bill if done without planning.

Another strategy is to keep withdrawals from traditional IRAs or 401(k)s as low as possible before required minimum distributions begin. Once RMDs start, you have less control over taxable withdrawals.

For people born before 1960, RMDs do not begin until age 73. Social Security can start as early as age 62, so there is a window in which careful withdrawal planning may help limit taxes.

Taxes on Social Security benefits are frustrating, especially because those benefits are earned through work. But the rules are unlikely to change soon, so it helps to know how they work and look for ways to reduce the tax burden.