When people think about retirement, they often look forward to getting their Social Security benefits. They hope these benefits will let them live comfortably or even fulfill some dreams. But, the reality might be different.
The average monthly Social Security payment for retired workers is around $1,917, but your amount could be higher or lower. This article will explain how Social Security benefits work, how to estimate them, and how to avoid paying too much tax on them.
Factors Affecting Your Social Security Benefits
Lifetime Earnings and Age
The amount you get from Social Security depends on two main things: your lifetime earnings and the age you start claiming benefits. If you wait until your full retirement age (FRA), you get your full benefit based on your income history.
If you claim benefits earlier, your payments will be smaller. If you delay claiming until age 70, your monthly benefit will be higher. This means you have some control over how much you will get.
Estimating Your Benefits
It’s important to estimate your future Social Security benefits before you retire. The best way to do this is by creating an account on the SSA’s website. There, you can see your annual earnings statements and get an estimate of your monthly benefit.
While getting closer to retirement usually gives you more accurate estimates, taxes can still affect the actual amount you receive.
Taxation of Social Security Benefits
Understanding Tax Rules
Many people think Social Security benefits are not taxed, but this is only true if Social Security is your only income. If you have other income, you might have to pay taxes on your benefits. Federal and state taxes can differ, so it’s important to understand both.
Combined Income
Your Social Security benefit taxation depends on your combined or provisional income. This is calculated by adding half of your annual Social Security benefit to your other income, including tax-free interest from investments.
If your combined income is over $25,000 (single filers) or $32,000 (joint filers), you will start to pay taxes on your benefits.
Avoiding Taxes on Social Security Benefits
Strategies to Reduce Taxes
Many retirees pay taxes on their Social Security benefits because of income from traditional IRAs or 401(k) plans. To avoid this, you can save in a Roth IRA or Roth 401(k). Withdrawals from Roth accounts do not count toward combined income because they are not taxable income.
For example, if a single person gets $2,800 a month from Social Security, that’s $33,600 a year. Half of this is $16,800, which is close to the $25,000 threshold where taxes on benefits start. If this person has no other taxable income and only withdraws from a Roth IRA, their Social Security benefits might not be taxed.
Benefits of Roth Accounts
Roth accounts are helpful because withdrawals from them do not increase your provisional income. This can keep your Social Security benefits tax-free. However, the income thresholds for taxing Social Security benefits have not been updated for many years, so even a small additional income can push you over the limit.
Planning for retirement involves understanding how Social Security benefits work and how taxes can affect them. Knowing your lifetime earnings and choosing when to start claiming benefits can help you maximize your monthly payments.
Creating an account on the SSA website can help you get an accurate estimate of your benefits. Using Roth accounts can help you avoid taxes on your Social Security benefits. Staying informed and making smart financial choices can ensure a more comfortable retirement.
FAQs
How is my Social Security benefit amount determined?
Your benefit amount is based on your lifetime earnings and the age you start claiming benefits. Waiting until your full retirement age (FRA) gives you the full benefit.
How can I estimate my future Social Security benefits?
You can estimate your benefits by creating an account on the SSA’s website and checking your annual earnings statements.
Are Social Security benefits taxed?
Yes, they can be. If you have other income besides Social Security, you might have to pay taxes on your benefits.
What is combined income?
Combined income is half of your annual Social Security benefit plus your other income, including tax-free interest from investments.
How can I avoid paying taxes on my Social Security benefits?
You can save in a Roth IRA or Roth 401(k), as withdrawals from these accounts do not count toward combined income.