Written by Alex Seleznev, MBA, CFP®, CFA | Dec 18, 2024
Several of our clients are going to collect their Social Security benefits for the first time at the beginning of next year. For each of these clients, we have a specific strategy explaining why they need to begin their benefits at this particular time. I will certainly talk about different Social Security claiming strategies in one of our future newsletters.
What came as a surprise to me is that some of our clients were not fully aware their benefits would actually be taxed. I’m hoping to clarify and address some of the most common questions when it comes to Social Security taxability.
Is Social Security taxed at the federal level?
Yes, Social Security benefits can be taxed at the federal level, but it depends on your total income and filing status.
The IRS uses a formula based on your "combined income," which includes your:
- Adjusted gross income (AGI)
- Plus: nontaxable interest
- Plus: 50% of your Social Security benefits
If your combined income exceeds certain thresholds, a portion of your benefits becomes taxable.
For individuals, if combined income is between $25,000 and $34,000, up to 50% of benefits may be taxable. If it exceeds $34,000, up to 85% could be subject to federal tax.
For married couples filing jointly, the thresholds are higher: $32,000 to $44,000 for 50% taxation and above $44,000 for up to 85% taxation.
However, no more than 85% of Social Security benefits are ever taxed.
Is Social Security taxed at the state level?
It depends on where you live.
Currently, most states do not tax Social Security benefits, but 8 states do impose some level of taxation.
States that tax Social Security benefits include Colorado, Connecticut, Minnesota, Montana, New Mexico, Rhode Island, Utah, and Vermont.
Each state has its own rules and income thresholds that determine how much of your Social Security benefits will be taxed.
How to minimize my Social Security taxes?
It won’t be easy for you to minimize your Social Security taxes.
As I mentioned earlier, the income thresholds for 50% or 85% taxability of the benefits are relatively low.
If you have a pension or work part-time, you will likely pay at least some taxes on your Social Security benefits.
In some rare cases, it’s possible to structure your portfolio distributions in a way that covers your cash needs and keeps your income under the 50% threshold.
This worked for a few of our clients in the past, but it won’t be possible or practical in many cases.
How much should I withhold from my Social Security benefits?
This is a good question and preferably should be addressed before you even begin collecting your benefits.
You can withhold 7%, 10%, 12%, or 22% for federal taxes. You can also opt out of tax withholding.
Some advisors suggest that you do not withhold anything from your Social Security benefits and pay your taxes differently. Even though this is a viable option, I believe withholding a certain amount is a more practical choice.
Social Security is a lifetime benefit and doesn’t change much over time (the cost of living adjustment for 2025 is 2.5%). If you withhold 12% or even 22%, it will likely be easier for you to manage your tax liability on other income, such as Required Minimum Distributions (RMDs) and pensions.
What else should I know when I begin to collect my Social Security benefits?
Most people prefer to pay their Medicare premiums directly from their Social Security payments.
One potential issue with this approach is that Medicare Part B and Part D premiums are based on your income and can change.
There is also a two-year lookback, which means that your 2025 Medicare premium will be based on your 2023 income.
If, as an example, your portfolio generated significant capital gains in 2023, your Medicare premiums in 2025 will likely be much higher than in the previous year.
This tends to lead to unpleasant surprises when people find out that their Social Security checks are much lower than originally anticipated.