Planning ahead for this major expense before claiming Social Security could save you thousands.
Social Security can play a critical role in your retirement budget. Sixty percent of retirees said Social Security is a major source of their income in the most recent iteration of an annual Gallup poll. Another 28% said it was at least a minor source. Either way, you'll want to make the most of your Social Security benefits if you can.
But one thing that can trip up a lot of retirees is not properly planning ahead. Getting your finances in order before you claim Social Security is essential if you want to get the most out of the government program. And planning goes well beyond deciding what age to apply for benefits.
There's a big thing you need to consider before you claim benefits.
Image source: Getty Images.
How the government taxes Social Security
To determine income taxes on Social Security, the IRS uses a special metric called combined income to calculate the portion of your benefits, if any, that are taxable income in any given year. Combined income is equal to half your Social Security benefits, plus your adjusted gross income, plus any non-taxable interest income. If your combined income exceeds a certain threshold, a portion of your Social Security benefits becomes taxable up to 85%.
Here are the thresholds:
| Percentage Taxable | Individual Filer | Joint Filer |
|---|
| 0% | Less than $25,00 | Less than $32,00 |
| Up to 50% | $25,000 to $34,000 | $32,000 to $44,000 |
| Up to 85% | More than $34,000 | More than $44,000 |
Data source: Social Security Administration.
You may notice those thresholds are extremely low. That's because they haven't been updated for inflation in over 30 years, and there's no plan to update them in the future. As a result, taxes on Social Security benefits are becoming harder and harder to avoid.
It's important to note that withdrawals from traditional IRAs, 401(k)s, and other pre-tax retirement accounts will count toward your combined income. So will capital gains on the sale of investments, even if they're subject to the 0% federal income tax rate on long-term gains. However, withdrawals from a Roth account will not count toward your combined income, which can be great for those who plan ahead.
Avoid paying extra taxes in retirement
Social Security taxes become a significant expense when your spending requirements push you to withdraw enough to push more and more of your Social Security benefits into taxable territory. At its worst, an extra dollar withdrawn from your traditional retirement account could result in an additional $1.85 of taxable income. If you're in the 22% tax bracket, you're effectively paying over $0.40 in additional taxes for each extra dollar you withdraw from your retirement account.
That's a situation you may be able to avoid, though.
The simplest way to avoid it is by using Roth conversions before you start taking Social Security. If you have a few years in early retirement before claiming Social Security, you can convert some of your traditional retirement assets in an IRA or 401(k) into a Roth IRA. You'll owe taxes on the amount you convert in the year you make the conversion. But then you won't owe any taxes on the assets when you withdraw them. Even better, they won't count toward your adjusted gross income or combined income.
Image source: Getty Images.
As such, it can make sense for retirees to use Roth conversions to fill the 22% tax bracket if they aren't already maxing it out. For example, if you're an individual who needs $70,000 per year in retirement, you can withdraw the entire amount from a traditional IRA and still have room to convert about $45,000 to a Roth IRA at a 22% tax rate, assuming you take the standard deduction.
Taking the tax hit now can save you from taking a much larger tax hit later. You may also want to consider taking capital gains now. Capital gains get a preferred tax rate depending on your income. But if your capital gains increase your combined income above the thresholds, the effective tax rate you end up paying is much higher.
If you plan well in advance of taking Social Security, the big tax challenge can be avoided. Every person's situation is different though. It may be worthwhile to pay for an hour or two of a financial planner's time to determine a proper strategy to mitigate your overall tax bill in retirement well before you claim Social Security.
FAQs
You can avoid this scenario by waiting until your full retirement age to begin taking benefits. This is 66 or 67 for most people, depending on when you were born. But there's a third option: Delay benefits until age 70. In doing so, you can get a Social Security bonus in the form of a higher benefit amount.
How to increase your Social Security benefits before you retire? ›
Don't overlook spousal, dependent, and survivor benefits.
- Strategies to Boost Your Benefits.
- Work for 35 Years.
- Wait Until at Least FRA to Collect Benefits.
- Collect Spousal Benefits.
- Receive Dependent Benefits.
- Monitor Your Earnings.
- Watch Out for Tax Bracket Creep.
- Apply for Survivor Benefits.
Paused benefits earn delayed retirement credits for every month they're suspended until age 70. That can boost your benefits by 8% a year for a maximum of three years, resulting in a 24% bump. It's unclear how many people are taking the do-over.
How important is Social Security to retirees? ›
Social Security benefits are the most important source of U.S. retirement income. Over time, however, trends in employer-provided pension offerings, societal changes, and Social Security program rule changes have altered the distribution of income by source among the aged population.
What is the Social Security bonus most retirees overlook? ›
The $22,924 Social Security bonus most retirees completely overlook. Offer from the Motley Fool: If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income.
How do I get my $16728 Social Security bonus? ›
Have you heard about the Social Security $16,728 yearly bonus? There's really no “bonus” that retirees can collect. The Social Security Administration (SSA) uses a specific formula based on your lifetime earnings to determine your benefit amount.
How do you get extra money added to your Social Security check? ›
Additional work will increase your retirement benefits. Each year you work will replace a zero or low earnings year in your Social Security benefit calculation, which could help to increase your benefit amount. Social Security bases your retirement benefits on your lifetime earnings.
What is the best advice on Social Security benefits? ›
Working for 35 years or more will help ensure you get the most money when your benefit amount is calculated. Earn as much as you can right up until full retirement age (or past it) to max out your benefit. If you wait until age 70 to claim, you can increase your benefit by 8% a year beyond your full retirement age.
How do I get an increase on my Social Security benefits? ›
Some ways to increase your Social Security payments include:
- Work at least 35 years.
- Earn more if possible.
- Work until full retirement age.
- Delay claiming until age 70.
- Claim spousal payments.
- Include family.
- Know retirement earning limits.
- Minimize Social Security taxes.
Social Security and Supplemental Security Income (SSI) benefits for more than 71 million Americans will increase 3.2 percent in 2024. Read more about the Social Security Cost-of-Living adjustment for 2024.
September's Supplemental Security Income payment, worth up to $943, will be given to millions of beneficiaries in 14 days. The September SSI payments are distributed on Sept. 1 and are given to people living with debilitating disabilities that impact their income, according to the Social Security Administration.
What is the #1 reason to take Social Security at 62? ›
1. You're Planning Your End-of-Life Care. Your Social Security benefits stop paying at your death, so if you die before collecting benefits, you'll have missed out on benefits entirely. You need to figure out how to maximize your Social Security income instead.
When a husband dies, does his wife get his Social Security? ›
Surviving spouse, any age, with a child younger than age 16, gets 75% of the worker's benefit amount. Child gets 75% of the worker's benefit amount. There's a limit to the benefits we can pay to you and other family members each month. The limit varies between 150% and 180% of the deceased worker's benefit amount.
At what age do you get 100% of your Social Security? ›
The full retirement age is 66 if you were born from 1943 to 1954. The full retirement age increases gradually if you were born from 1955 to 1960 until it reaches 67.
How much money can you have in the bank on Social Security retirement? ›
To be eligible for SSI, your assets must be less than $2,000 for an individual and less than $3,000 for a married couple. However, not all assets count towards the resource limits. The Social Security Administration lists 44 resource exclusions.
What is the one-time payment from Social Security? ›
* If you get your Social Security or SSI benefit payment in the mail, we'll send your $250 one-time payment by mail. * If your benefit goes directly to your Direct Express debit card, we'll deposit the $250 one-time payment to your debit card.
At what age is Social Security no longer taxed? ›
Yes, Social Security is taxed federally after the age of 70. If you get a Social Security check, it will always be part of your taxable income, regardless of your age. There is some variation at the state level, though, so make sure to check the laws for the state where you live.
Why did I get an extra Social Security payment this month? ›
It's all because of a quirk in the Social Security Administration's payment schedule. A few times a year, two Supplemental Security Income (SSI) checks will go out in a month instead of the usual one.
What is a strange but true free loan from Social Security? ›
The brief's key findings are: An unconventional strategy allows individuals to use early Social Security benefits like a “free loan,” paying back the principal while keeping the interest. If this strategy were widely adopted, it would cost Social Security $6 billion to $11 billion per year today and more in the future.
