Unprepared retirees’ finances will be blown to smithereens by the Social Security tax “torpedo” if unprepared.
Depending on your salary and other factors, anything from half to three-quarters of your Social Security benefit might be subject to taxation.
The top percentage of your income moves into the next tax bracket if your Social Security income increases your marginal tax rate. Retirees may be surprised that they pay more taxes and get fewer Social Security benefits than they bargained for.
After you retire, your taxes will be calculated using your MAGI plus half of your Social Security payments and any interest that is not taxable, often from municipal bonds. Your ‘combined income,’ the final tally, is subject to various tax rates based on the filer’s amount and position.
For instance, half of taxpayers’ benefits are subject to taxation if their total income falls between $25,000 and $34,000. Taxes on 85% of the benefits for those with incomes over this threshold are withheld. Taxes are due on half of the benefits married couples receive whose joint income is between $32,000 and $44,000. Above this threshold, 85 percent of the benefits are subject to taxation.
Never fear—the tax torpedo isn’t cause you to see 85 percent of your Social Security income go. The actual amount you’ll have to pay in taxes is 85 cents out of every dollar you get from Social Security. Furthermore, due to the operation of tax brackets, your effective income tax rate varies across all income levels. Taxes in the United States are progressive, meaning that they increase as your income does.
Suppose you are a single taxpayer in 2023 with $50,000 in total taxable income (thus subject to the 22% tax rate for amounts over $44,725). There is $35,000 in your income, including $15,000 from Social Security. Due to your exceeding the $34,000 combined income limit, 85% of your Social Security payments will be subject to taxation.
In this case, you would have to pay taxes on $12,750, or 85% of your Social Security payout, at the highest marginal rate of 22%. You will incur a $2,805 charge due to your Social Security taxes. You would only have to pay $1,650 in taxes on half of your Social Security benefits if your joint income was $34,000 or less.
It is a good idea to consult a financial counselor to reduce your tax liability in your retirement years.