Social Security pays the average retired worker today $1,918 a month. And many seniors rely heavily on that money to make ends meet once they stop working.
You may be looking forward to getting a monthly benefit from Social Security once your retirement begins. But if you're planning on keeping your monthly Social Security check in full, here's some potentially disappointing news -- you may not get to. That's because the IRS might come after a portion of those benefits.
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Will your Social Security get taxed?
If Social Security is your only source of retirement income, then chances are, you'll be able to keep your monthly benefits in full. It's when outside income gets thrown into the mix that taxes on Social Security start to apply.
The problem with taxes on Social Security benefits is that they come into play at pretty low income thresholds. But they're based on a specific type of income -- combined or provisional income, which is calculated as 50% of the amount of Social Security you receive each year plus additional income that must be reported on your tax return.
If you're a single tax-filer, a combined income of $25,000 to $34,000 leaves you subject to taxes on up to 50% of your Social Security benefits. Once your combined income exceeds $34,000, you risk taxes on up to 85% of your benefits.
If you're married filing a joint tax return, a combined income of $32,000 to $44,000 leaves you subject to taxes on up to 50% of your benefits. Beyond $44,000, up to 85% of your Social Security may be taxed.
As you can see, these are pretty low thresholds. Say you're single and collect $1,918 a month from Social Security, or roughly $23,000 per year. Half of that is $11,500. That alone won't require you to pay taxes on your benefits. But if you also have access to $14,000 a year between your investments and retirement plan withdrawals, that bumps you up to a combined income of $25,500 -- and makes it so you're not keeping your Social Security benefits in full.
How to avoid paying taxes on your Social Security income
Given how low the aforementioned thresholds are, you might assume that you're doomed to be taxed on your Social Security benefits. But one thing you should know is that withdrawals from a Roth retirement plan aren't considered income for the purpose of the calculations above.
So going back to our example, say that half of your annual Social Security benefit is $11,500, and you receive $3,500 a year in dividend and interest income in a non-tax-advantaged account. If you then take another $10,500 per year out of a Roth IRA, that won't raise your combined income. And a combined income of $11,500 plus $3,500, or $15,000, won't leave you paying taxes on your benefits.
If you're nearing retirement and have been keeping your savings in a traditional IRA or 401(k), you may want to consider a conversion to a Roth -- not just for the reason above, but to enjoy the benefit of tax-free withdrawals during your senior years.
