I often get questions about the tax consequences of Social Security benefits.
Whether or not Social Security benefits will be taxed depends on a concept called Provisional Income, which was created by the IRS. Provisional Income combines an individual’s adjusted gross income, half of their Social Security benefits, and any tax-exempt interest. Depending on the total amount of Provisional Income for the year, Social Security benefits may be subject to taxation at the federal level.
The chart below will help you calculate what percentage of your Social Security benefits would be subject to taxation based upon your income tax filing status and total amount of provisional income for the year:
Note that the chart is not adjusted each year for inflation. Therefore over time more and more Social Security benefits have become subject to federal income tax.
If you plan creatively, you may be able to reduce Provisional Income by drawing on tax-free sources of income that do not land on the federal 1040 form. These income sources include withdrawals from Roth IRA accounts and tax-free loans from the cash value of permanent life insurance policies.
Whether or not Social Security benefits are taxed at the state level depends on the laws of each state. California, for example, does not tax Social Security benefits. In fact there are many states that do not. Part of your retirement planning may include finding a retirement destination state that is retiree friendly to the taxation of Social Security benefits.
If you have any questions about this taxation of Social Security benefits, please contact me