A Surprise Social Security Tax Bill Could Be Waiting for You in Retirement. Here's How to Avoid It.

A lot of people expect to start collecting Social Security once they retire. But if you’re assuming you’ll get to keep your monthly benefits in full, you may want to rethink that.

Many retirees don’t realize that Social Security benefits can be subject to federal taxes. And the thing that determines whether your benefits are taxed is something called combined or provisional income. Let’s review what that is – and the steps you can take to lower yours and keep more of your Social Security for yourself.

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How taxes on Social Security benefits work

Whether you’re subject to taxes on Social Security or not depends on something called your combined or provisional income. It’s calculated by taking the total of your adjusted gross income, tax-free income, and 50% of the Social Security benefits you receive each year.

• If your combined or provisional income exceeds $25,000 as a single tax filer or $32,000 as a joint tax filer, you could face taxes on up to 50% of your Social Security benefits.
• If your combined or provisional income exceeds $34,000 as a single tax filer or $44,000 as a joint filer, you could face taxes on up to 85% of your Social Security benefits.

These limits are not indexed to inflation, so they don’t increase every year the same way Social Security’s cost-of-living adjustments (COLAs) or yearly wage caps do.

How to reduce your chances of having your Social Security benefits taxed

If you don’t like the idea of paying taxes on your Social Security benefits, it’s important to know that these common income streams could make those taxes more likely:

• Withdrawals from traditional retirement accounts like IRAs and 401(k)s
• Required minimum distributions (RMDs)
• Capital gains from investments

If you want to reduce the likelihood of having your Social Security checks taxed, here are some things you can do:

• Save in a Roth IRA or 401(k) during your working years, since Roth withdrawals don’t count toward combined or provisional income.
• Do Roth conversions before claiming Social Security.
• Spread out withdrawals from traditional retirement accounts to keep your income below the above thresholds.
• Be strategic with capital gains and space out the sale of assets.

Of course, avoiding taxes on Social Security isn’t always possible. If you’ve saved a lot of money in a traditional retirement account and don’t have an opportunity to do a Roth conversion, you may inevitably end up having your benefits taxed once RMDs begin. But it’s important to understand why some retirees pay taxes on their Social Security so you can either take steps to avoid that or know how to plan for those taxes accordingly.