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Are Social Security Benefits Taxed?

Yes, but with a nod to Paul Harvey, there is a “rest of the story”. It isn’t as simple as adding your benefit check to your taxable income and paying taxes at your marginal rate.

Social Security retirement benefits are an important part of retirement. For about 62% of retirees, Social Security represents at least half of their total retirement income. That is a significant amount. Further, the demise of Social Security is largely over-hyped.

Clearly, it is important to understand how Social Security benefits are taxed.

Some retirees are surprised to learn that Social Security benefits are taxed in the first place. Even for those who aren’t surprised, understanding how they are taxed is a separate matter.

How much of your Social Security Benefit is Taxable?

Only a portion of your Social Security retirement benefit is taxable. The portion is not a fixed percentage, and changes based on a figure known as your provisional income. I’ll explain provisional income in the next section.

There are three different levels of provisional income to consider. These levels are based on a lower provisional income base amount, and an upper base amount.

For single retirees, the lower base is $25,000 and the upper base is $34,000.

For married couples that file jointly, the lower base is $32,000 and the upper base is $44,000.

If your provisional income falls below the lower base, then you owe taxes on none of your Social Security retirement benefit.

If your provisional income is above the lower base, but less than the upper base, you owe taxes on 50% of your Social Security benefit.

Lastly, you owe taxes on 85% of the amount of your Social Security benefit that is above the upper base.

I’ll illustrate some examples after I explain how to calculate your provisional income. For now, understand that the number above are progressive, and you will never owe taxes on more than 85% of your benefit.

Provisional Income

Your provisional income is different than your gross income. You find your gross income by adding:

  1. Half of your Social Security benefit
  2. The rest of your income. For this amount, you ignore tax-free distributions from Roth accounts. This is the normal treatment of Roth distributions. However, you DO count tax-exempt interest income.

As an example, assume you receive $20,000 in Social Security benefits for the year. Half of that is $10,000. Add that to any withdrawals you take from your IRA or 401k (assuming they aren’t Roth accounts) and you have your provisional income. If you take $65,000 in withdrawals, you have $75,000 in provisional income.

Figuring out the taxable portion of Social Security

Low Provisional Income

Let’s look at an example of someone who has a relatively low provisional income. From the example above, let’s assume someone takes a smaller distribution from their IRA. Someone who takes a $30,000 withdrawal will have $40,000 in provision income.

First, consider the amount that is above the lower base but lower than the upper base ($25,000 – $34,000). There is a $9,000 gap there. 50% of that is taxable, so $4,500.

Next, consider the amount of provisional income that is above the upper base ($34,000 – $40,000). $6,000 of their provisional income is above the upper base. 85% of that is taxable, so $5,100.

Combining $4,500 with $5,100 gives a total taxable amount of $9,600. This the amount of Social Security benefit that is taxable.

High Provisional Income

Taking the $75,000 figure from above, how much of a single retirees Social Security benefit is taxable?

Again, consider the amount that is above the lower base but lower than the upper base ($25,000 – $34,000). There is a $9,000 gap there. 50% of that is taxable, so $4,500.

Next, consider the amount that is above the upper base ($34,000 – $75,000). There is $41,000 in provisional income above the upper base. 85% of that is taxable, so $34,850.

Add $4,500 and $34,850 to get a total of $39,350.

Notice in this case that the $39,350 is more than 85% of their benefit. In fact, it is more than their entire benefit! Since no more than 85% of your Social Security benefit is taxable, you would only owe taxes on $17,000 ($20,000 x 85%). Think of it as a backstop to the taxability of your Social Security benefit.

Taxation of Social Security

Be careful to realize here that all of the preceding discussion was to determine the amount of Social Security benefit that is taxable. Of the amount of your Social Security benefit that is taxable, you pay taxes at your marginal rate.

Assume you owe taxes on the maximum $17,000 above. Further assume that you are in the 24% tax bracket. You would owe $4,080 in taxes.

To put it all together:

You receive $20,000 in Social Security retirement benefits.

You owe taxes on $17,000 of your benefit.

You pay $4,080 in taxes.

Again, there isn’t a single taxable percentage or rate for Social Security benefits. The amount of taxes that you will owe on your Social Security benefit depends on your income, benefit amount, and tax rate.

…And now you know the rest of the story.

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