This article is reprinted by permission from NerdWallet. The investing information provided on this page is for educational purposes only. NerdWallet, Inc. does not offer advisory or brokerage services, nor does it recommend or advise investors to buy or sell particular stocks, securities or other investments. Social Security benefits were once tax-free. That changed in 1983, when Congress decided to tax a portion of benefits for the highest-income recipients.
Back then, fewer than 10% of beneficiaries were affected. Lawmakers failed to update the law to account for inflation, however, so today most Social Security beneficiaries have to pay federal income tax on at least some of their benefits, says Ted Sarenski, author of American Institute of CPA’s “Guide to Social Security Planning.” There are a few ways to reduce that tax bite, however, especially if you can plan ahead.How Social Security taxes work Social Security taxes are based on your annual “combined income.” Combined income comprises:
Your adjusted gross income, which includes your earnings, investment income, retirement plan withdrawals and other taxable income.
Any nontaxable interest you receive, such as interest on municipal bonds.
One half of your Social Security benefits.
For couples filing a joint return, a combined income between $32,000 and $44,000 means up to 50% of benefits may be taxable. For higher combined incomes, up to 85% of benefits may be taxable. Single filers may pay tax on up to 50% of benefits when combined income is between $25,000 and $34,000, and up to 85% of benefits beyond that. People who live solely on Social Security don’t have to pay income taxes on their benefits, Sarenski notes. But even a relatively small amount of other income can cause benefits to become taxable.Defuse the tax torpedo The unique way Social Security benefits are taxed leads to something known as the “tax torpedo” – a sharp rise in marginal tax rates followed by a decline, says William Reichenstein, professor emeritus at Baylor University and co-author of “Social Security Strategies: How to Optimize Retirement Benefits.” Marginal tax rates are what you pay on each additional dollar …
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