Simplifying Your Social Security Taxes
During your working years, your employer probably withheld payroll taxes from your paycheck. If you make enough in retirement that you need to pay federal income tax, then you will also need to withhold taxes from your monthly income.
To withhold taxes from your Social Security benefits, you will need to fill out Form W-4V . The form only has only seven lines. You will need to enter your personal information and then choose how much to withhold from your benefits. The only withholding options are 7%, 10%, 12% or 22% of your monthly benefit. After you fill out the form, mail it to your closest Social Security Administration office or drop it off in person.
If you prefer to pay more exact withholding payments, you can choose to file estimated tax payments instead of having the SSA withhold taxes. Estimated payments are tax payments that you make each quarter on income that an employer is not required to withhold tax from. So if you ever earned income from self-employment, you may already be familiar with estimated payments.
In general, its easier for retirees to have the SSA withhold taxes. Estimated taxes are a bit more complicated and will simply require you to do more work throughout the year. However, you should make the decision based on your personal situation. At any time you can also switch strategies by asking the the SSA to stop withholding taxes.
How Much Of Your Social Security Is Taxable
Its possible and perfectly legal to avoid paying taxes on your Social Security check. In fact, only about 40 percent of recipients pay any federal tax on their benefit.
But heres the caveat: To receive tax-free Social Security, your annual combined, or provisional, income must be under certain thresholds:
- $25,000, if youre filing as an individual
- $32,000, if youre married filing jointly
For married filing separately, the Social Security Administration simply says that youll probably pay taxes on your benefits.
Your combined income consists of three parts:
- Your adjusted gross income, not including Social Security income
- Tax-exempt interest
- 50 percent of your Social Security income
Add those amounts up and if youre under the threshold for your filing status, you wont be paying federal taxes on your benefit.
Even if youre above this threshold, however, you may not have to pay tax on your full benefit. You may pay taxes on only 50 percent of your benefit or on up to 85 percent of it, depending on your combined income.
- For individual filers:
- Combined income between $25,000 and $34,000, up to 50 percent of your benefit is taxable
- Combined income above $34,000, up to 85 percent of your benefit is taxable
How Much Social Security Income Is Taxable
Not all taxpayers are required to pay federal income taxes on their Social Security benefits. Typically, only those individuals who have substantial income in addition to their Social Security benefits are required to pay federal income taxes on Social Security Benefits. If you do have to pay taxes on your Social Security benefits, you can either make quarterly estimated tax payments to the IRS or elect to have federal taxes withheld from your benefits.
How much of your Social Security income is taxable is based on your combined income. Your combined income is calculated by adding your adjusted gross income, nontaxable interest, and one-half of your Social Security benefits.
If you file your federal income taxes as a single person, and your combined incomeis between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits. If your combined income is more than $34,000, up to 85% of your benefits may be taxable. If your combined income is below $25,000, all of your Social Security income is tax-free.
If you are married and file a joint return, and you and your spouse have a combined income that is between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits. If your combined income is more than $44,000, up to 85% of your benefits may be taxable. If your combined income is below $32,000, all of your Social Security income is tax-free.
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Social Security And Medicare Withholding Rates
The current tax rate for social security is 6.2% for the employer and 6.2% for the employee, or 12.4% total. The current rate for Medicare is 1.45% for the employer and 1.45% for the employee, or 2.9% total. Refer to Publication 15, , Employer’s Tax Guide for more information or Publication 51, , Agricultural Employers Tax Guide for agricultural employers. Refer to Notice 2020-65PDF and Notice 2021-11PDF for information allowing employers to defer withholding and payment of the employee’s share of Social Security taxes of certain employees.
What Benefits Does Social Security Disability Insurance Offer
The amount you receive from Social Security Disability Insurance depends on your average lifetime earnings before your disability began. Generally, the more you earned over a longer period, the more you’ll benefit, up to a maximum amount. The Social Security Administration calculates your disability benefit based on the amount of your Social Security “covered earnings.” Generally, these are your past earnings that have been subject to Social Security tax.
Your benefits are determined by averaging your covered earning over the 35-year period representing your top earning years. The SSA sees this as your average indexed monthly earnings . The SSA then applies a formula to your AIME to calculate your primary insurance amount . This serves as the base figure for the SSA to calculate your Social Security Disability Insurance benefit amount.
To understand your entire covered earnings history, the SSA provides access to your annual Social Security Statement. If you receive other disability benefits from private insurers, this will not impact your Social Security Disability Insurance benefits.
The Social Security Disability Insurance program rules limit your overall benefit under certain conditions. The combination of Social Security Disability Insurance and other government-sponsored disability programs cannot be more than 80% of the average amount earned before you became disabled. If this happens, the SSA will reduce your payments.
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Make Sure Youre Taking Your Maximum Capital Loss
If youve invested in stocks or bonds and have a loss on paper, you might want to sell and realize that loss so you can claim it as a tax deduction. The process is called tax-loss harvesting, and it can net you a sizable deduction from your income.
The tax code allows you to write off up to a net $3,000 each year in investment losses. A write-off first reduces any other capital gains that youve incurred throughout the year. For example, if you have a $3,000 gain on one asset but a $6,000 loss on another, you can claim a deduction for the full $3,000 net loss.
Any net loss beyond that $3,000 has to be carried forward to future years, at which point it can be used. And even if you cant realize the full value of that net loss, it can still make sense to realize some loss, especially if it pushes your Social Security benefit into the tax-free area.
Tax-loss harvesting works only in taxable accounts, not special tax-advantaged accounts such as an IRA.
Who’s Eligible For Social Security Disability Insurance
In addition to meeting the disability requirements, you must have worked long enough and recently enough to qualify for Social Security Disability Insurance.
First, you must meet the work test. This test is based on Social Security work credits and requires you to earn at least a minimum amount of income in wages or self-employment income per calendar year. For each $1,470 in wages or self-employment income that you earn per year you earn one credit. You can earn up to four credit per year. When you’ve earned $5,880 in 2021, you’ve earned your four credit for 2021.
Typically, you need at least 40 credits with 20 of these earned in the last 10 year period ending with the year of your disability. However, meeting the work test requirement can also depend on your age. It requires different amounts of Social Security credits since younger workers typically have not had enough time in the workforce to earn the full 40 credits. For those:
- Under age 24: You meet the work test if you earned 6 credits in the 3-year period when your disability began.
- Age 24 to 31: In general, you may qualify if you have credits equivalent to working half the time between age 21 and becoming disabled.
- Age 31 or older: You’ll need to have earned at least 20 credits in the 10-year period immediately before becoming disabled.
Second, review the Social Security Administration’s table to determine if you meet the duration of work test based on your age and when your disability began.
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Donate Your Required Minimum Distribution
If you cant wiggle out of taking your RMD from a traditional IRA, then donate it to charity to get into the tax-free zone. The donation could allow you to deduct the amount from your adjusted gross income. But youll have to be eligible for the qualified charitable distribution rule, including being over age 72 and paying the distribution directly from the IRA to the charity.
Thats a strategy that Crane suggests, though he acknowledges that some people will have too much income and simply wont be able to lower their adjusted gross income.
But It Can’t Tell You The Best Time To Claim
The benefits calculator is a useful tool for estimating your monthly benefit, but it can’t tell you when to sign up to claim your largest lifetime benefit. You must decide that for yourself, and it often comes down to life expectancy. Claiming earlier means more years of checks, but each check is smaller, while delaying leads to larger checks but fewer of them.
If your goal is to claim the largest lifetime benefit, you can figure out which starting age is best with some basic math. First, take your estimated monthly benefit and multiply it by 12 to get your estimated annual benefit. Then, multiply that by the number of years you expect to claim checks. For example, a $2,000 monthly benefit would give you $24,000 per year. And if you claimed for 20 years, you’d get $480,000 overall.
Repeat this process for a few claiming ages to see which provides you with the largest benefit overall based on your estimated life expectancy. Then, try to put off claiming until that age. If that’s tough for you financially, you may have to sign up earlier than you’d like.
Another thing worth noting is that all the data the benefit calculator provides is based on the way the government calculates Social Security benefits right now. It’s possible the government alters the program in some way in the coming years to keep it sustainable for generations to come. If this happens, you may need to repeat the process above based on the new benefit estimates.
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Vermonts Social Security Exemption
Vermonts personal income tax exemption of Social Security benefits reduces tax liabilities mainly for lower- and middle-income Vermonters who are retired or disabled. It does this by excluding from taxable income all or part of taxable Social Security benefits reported on the federal Form 1040, U.S. Individual Income Tax Return, which are included in federal AGI. The exemption does not exclude other types of income.
For those who are married filing jointly and civil union partner filing jointly, the exemption applies in full up to an AGI of $60,000, phases out between $60,000-$70,000, and does not apply to filers with AGI greater than or equal to $70,000. For all other filing statuses, the Vermont exemption applies in full to an AGI up to $45,000. It then phases out smoothly for filers earning between $45,000-$55,000. It does not apply to filers with AGI greater than or equal to $55,000. The exemption reduces a taxpayers Vermont taxable income before state tax rates are applied.
Table 2 illustrates how the Vermont exemption is applied by filing status and income level. Graph 1 shows the percentage of taxable Social Security benefits that are exempt from Vermont taxable income based on filing status and AGI.
Ways To Avoid Taxes On Benefits
The simplest way to keep your Social Security benefits free from income tax is to keep your total combined income below the thresholds to pay tax. However, this may not be a realistic goal for everyone, so there are three ways to limit the taxes that you owe.
- Place retirement income in Roth IRAs
- Withdraw taxable income before retiring
- Purchase an annuity
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No Matter How You File Block Has Your Back
Social Security Tax Limits
The government bases the annual Social Security tax limits on changes in the National Wage Index , which tends to increase every year. The changes are intended to keep Social Security benefits on track with current inflation.
Any income you earn beyond the wage cap amount is not subject to a 6.2% Social Security payroll tax. For example, an employee who earns $165,000 in 2022 will pay $9,114 in Social Security taxes .
Keep in mind, however, that there is no wage base limit for Medicare tax. While the employee is only subject to Social Security tax on the first $147,00, they will have to pay 1.45% Medicare tax on the entire $165,000. Workers who earn more than $200,000 in 2022 are also subject to an 0.9% additional Medicare tax.
The combination of the increase in the Social Security tax limit and the additional Medicare tax for high-earners could result in lower take-home pay. Unfortunately, that means workers who earned over $200,000 in 2021 are at risk of owing more taxes in 2022.
Here is an example of how the Social Security limit works in 2021 and 2022:
|Social Security Tax Limit Example|
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What Is Social Security
Social Security is a federal program that pays monthly benefits to retirees, surviving spouses and children, and disabled people. An average of 65 million Americans collect Social Security monthly.
The money for Social Security, as well as Medicare, comes from a tax that every working American pays. It’s a 7.65% tax on every paycheck, or a 15.3% tax for self-employed people that covers both the employee and the employer portions. That tax is levied on the first $147,000 of a worker’s income in 2022.
So, while workers pay a tax to fund the Social Security program, other people are benefiting by collecting a monthly check. Those benefit checks are then often taxed as income, returning a portion of the money to the federal government.
Calculating Social Security Tax
If you do have to pay tax on your Social Security benefit, the amount will depend on your total income from all sources. For 2021, if your income as an individual is between $25,000 and $34,000, you’ll pay taxes on up to 50% of your income from Social Security. If your total income is more than $34,000, you’ll pay taxes on 85% of your Social Security.
If you’re and filing jointly, you’ll pay taxes on up to 50% of your Social Security if your total income is between $32,000 and $44,000. If your total joint income is over $44,000, you’ll pay taxes on 85% of your Social Security.
When you’re calculating the exact amount you need to include in your taxable income, it’s the lesser of either:
- Half of your annual Social Security benefits
- Half of the difference between your combined income and the Social Security base amount
For example, if your total annual Social Security benefit is $18,000, half of that is $9,000. If you’re filing individually, and your total income is $28,000, then half of the difference between your income and the Social Security base is $1,500 . So you would only be taxed on $1,500, since that’s less than half of your Social Security benefit.
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The Future Of Social Security Taxation
There have been a few proposals to eliminate the taxation of Social Security benefits, but with a looming shortfall in 2034, dont hold your breath for any proposal succeeding that would reduce revenues for the SSA. Taxes on Social Security benefits are probably here to stay.
Instead of waiting on the unlikely elimination of these taxes, start building a plan to potentially reduce or eliminate these taxes.
A Roth IRA is a good place to start. It is probably the most valuable tool for minimizing Social Security taxes. Why? Roth distributions are not included in your combined income!
If you think you may eventually be subject to taxes on your Social Security benefit, consider building a pool of money in your Roth account. You may be able to contribute to a Roth IRA up to $6,000 .
Check with your retirement plan at work, as well, to see if they offer a Roth option. Using a Roth in 2022 will allow you to put in up to $20,500 per year .
Finally, you may want to consider converting traditional IRAs to Roth IRAs. Theres certainly a lot to consider when doing so, but since the tax benefits could extend beyond the tax free nature of the Roth, this could be a winning move.
As a next step in your learning about this topic, you should consider joining the nearly 400,000 subscribers on my YouTube channel! This is where I break down the complex rules and help you figure out how to use them to your advantage.