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Beware the Social Security Tax Torpedo

Paying more taxes likely isn’t on your "bucket list," but your income in retirement does come with a tax burden—perhaps even your Social Security income. Many people are not familiar with the tax liability associated with Social Security payments, and the income generated from Social Security may be taxed at 0%, 50% or more depending on other factors. We call this the “Tax Torpedo” effect because, depending on your total income and marital status, as much at 85% of your Social Security benefit may be taxable. However, with careful planning, the impact can be minimized.

Calculating Potential Tax Owed
Generally speaking, if Social Security is your only income, your benefits will not be taxable. But if you have other income being generated from assets such as a pension or other savings vehicles, you could owe taxes on at least a portion of the government provided benefits.

You can estimate your tax liability by adding up all of your annual income sources other than Social Security. For most people, this is the sum of wages, taxable interest, realized capital gains, and other income, and it is called your “Modified Adjusted Gross Income” or MAGI.  To your MAGI, add one-half of your Social Security income. If this amount (known as your “Provisional Income”) is greater than the base amounts in the table below, you will owe taxes on a portion of your benefits.

  • $25,000 for single, heads of household, or qualifying widow/widower with a dependent child.
  • $25,000 for married individuals filing separately and who did not live with their spouses at any time during the tax year.
  • $32,000 for married couples filing jointly.
  • $0 for married individuals filing separately who lived together at any time during the tax year.

If your income exceeds the base amount for your filing status, your Social Security benefits are taxable. For some filers, the taxable portion can be as much as 85%. Take a look at the case study in this newsletter to see how one couple was impacted by taxes on their Social Security benefit. For some couples, the Tax Torpedo can effectively lower Social Security benefits by almost 30%!

Reducing the Tax Torpedo
So what can you do about the Tax Torpedo? — It's no secret that navigating the tax code is difficult. But there are a number of strategies that can reduce the amount of taxes you pay on Social Security benefits. Selecting your optimal age to begin benefits and managing the order in which you tap your assets for income are two such strategies that can make a material difference for you.