The Myth of Substantial Income Taxes on Social Security Benefits
Good to Know
Social Security Retirement Benefits (SSRBs) can be as high as $55,000 or more annually for high-income clients who choose to delay benefits claiming until age 70. But here’s the big question—how much of that SSRB will the IRS siphon away? We have good news! Many clients will pay income tax on a relatively small portion of the SSRB. However, clients can be misled when they read articles that assert “up to 85% of Social Security Benefits can be taxable.” While that assertion is technically correct, it does not tell the whole story. We’ll dispel the myth of significant income taxes on SSRBs as follows:
- Clarify exactly what “Taxable Income” means,
- Explain something called “Combined Income,”
- Show you the Social Security income inclusion requirements, and
- Provide examples.
What Does “Taxable Income” Mean?
IRS terminology can be confusing, even for professional advisors. We acknowledge that’s hardly a surprise but you may not be aware of how a specific term—taxable income—can have dramatically different tax meanings depending on its context.
- Taxable income is used generically in IRS publications to describe a taxpayer’s income that must be included in “total income”1 on a taxpayer’s tax return. For example, the IRS says a portion of SSRBs must be included in “taxable income” but that does NOT mean the income will be taxed!
- Yet, the individual income tax return has a line entitled taxable income,2 which describes the amount actually subject to income tax, after all deductions and credits have been taken on the tax return.
The income tax liability is calculated on taxable income as determined on Form 1040. Now we’re ready to explain how combined income impacts the taxation of SSRBs.
Combined Income
Combined income simply determines how much of your client’s Social Security Benefit must be included in their total income1 on their income tax return. The IRS definition of combined income follows. The comment within brackets is our plain English interpretation.
“To determine if their benefits are taxable [i.e. included in total income on the tax return], taxpayers should take half of the Social Security money they collected during the year and add it to their other income. Other income includes pensions, wages, interest, dividends and capital gains.”
Next, we’ll address how much of your client’s SSRB must be included in total income on the income tax return.
Social Security Inclusion Requirements
Up to 85% of Social Security Benefits must be included in a taxpayer’s total income according to the IRS. We added the underlined text in the IRS directive below for clarity.
“Fifty percent of a taxpayer's benefits may be taxable if they are:
- Filing single, head of household or qualifying widow or widower with $25,000 to $34,000 in combined income.
- Married filing separately and lived apart from their spouse for all of 2022 with $25,000 to $34,000 in combined income.
- Married filing jointly with $32,000 to $44,000 in combined income.
Up to 85% of a taxpayer's benefits may be taxable if they are:
- Filing single, head of household or qualifying widow or widower with more than $34,000 in combined income.
- Married filing jointly with more than $44,000 in combined income.
- Married filing separately and lived apart from their spouse for all of 2022 with more than $34,000 in combined income.”
Well thanks, IRS, that’s perfectly clear, right? If you’re anything like the author, nothing beats specific examples.
Examples
The examples below are based on the IRS calculator currently in effect.
Example 1:
Fact pattern:
- Clients: Mr. Jack and Mrs. Jill Doe
- SSRBs will be claimed when each reaches age 70
- They will qualify for delayed retirement credits
- Married filing jointly
- The couples’ income from pensions, IRAs, and other sources = $30,000
- Total income from all sources = $100,000
| FACTOR | AMOUNT |
| Jill’s SSRB with delayed claiming credits | $50,000 |
| Jack’s SSRB with delayed claiming credits | 20,000 |
| Income from pension, IRA, and other sources | 30,000 |
| Total income from all sources | $100,000 |
| Less: SSRBs excluded from taxation | -46,150 |
| Less: Standard deduction | -30,700 |
| Taxable income | $23,150 |
| Income tax liability | $2,338 |
Example 2:
Same fact pattern except Jill and Jack will claim retirement benefits at their normal retirement age of 67. They will not qualify for delayed claiming credits:
| FACTOR | AMOUNT |
| Jill’s SSRB with delayed claiming credits | $38,000 |
| Jack’s SSRB with delayed claiming credits | 15,200 |
| Income from pension, IRA, and other sources | 30,000 |
| Total income from all sources | $83,200 |
| Less: SSRBs excluded from taxation | -36,490 |
| Less: Standard deduction | -30,700 |
| Taxable income | $16,010 |
| Income tax liability | $1,601 |
Summary
Your clients may be pleasantly surprised at the relatively low marginal income tax rates during retirement of as little as 10% as demonstrated in example 2. When compared to total income in the examples, average income tax rates are about 2%. A savvy advisor or planner can impress clients and prospects by understanding the nuances discussed in this article. Get that sound understanding through our CFP® Curriculum when you consider CFP® certification. You’ll discover a select few of the reasons our students’ pass rates are much higher than the national averages.
Disclaimer
The information presented herein is provided purely for educational purposes and to raise awareness of these issues; it is not meant to provide and should not be used to provide legal, identity theft protection, investment, income tax, risk management, retirement, estate, or financial planning advice of any kind. An experienced and credentialed expert should be consulted before making decisions relating to the topics covered herein. There are variations, alternatives, and exceptions to this material that could not be covered within the scope of this blog.
1 For you technical diehards, see line 9, Page 1 on Form 1040 (2022).
2 Line 15, Page 1, Form 1040 (2022).
