When you reach the appropriate age, it’s easy to apply for Social Security retirement benefits – just go to Social Security’s website, fill out the online form and you’re essentially done. But many people overlook the next step – completing Form W-4V, which asks you how much federal income tax you want withheld from your benefits. And if you skip this step, you could face an unpleasant surprise when it’s tax-filing time, because Social Security benefits can indeed add to your taxable income.
Here are the details:
• If you’re a single filer…If your “combined” income is between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your Social Security benefits. (“Combined” income includes your adjusted gross income, non-taxable interest, and one-half of your annual Social Security benefits.) If your combined income is more than $34,000, up to 85 percent of your benefits may be taxable.
• If you’re married and file jointly…If you and your spouse have a combined income between $32,000 and $44,000, you may be taxed on up to 50 percent of your benefits. If your combined income is more than $44,000, up to 85 percent of your benefits may be taxable.
These numbers might seem high, but they don’t mean you’ll lose 50 percent, or 85 percent, of your benefits – they are just the percentages of benefits you may be taxed on, at your personal income tax rate.
To help avoid a big tax bill or an underpayment penalty, you can file Form W-4V with the Social Security Administration and request to have 7, 10, 12 or 22 percent of your monthly benefit withheld. Your tax advisor can help you choose the withholding percentage that’s appropriate for your situation.
The amount of taxes you may need to pay will also depend on when you start taking Social Security. The earlier you take benefits, the smaller your monthly checks, and the smaller the taxes. But taxes should not be a key issue in deciding when you need to begin collecting your payments. Rather, you should consider other factors, such as your anticipated life expectancy, your employment situation, your spending needs and the benefits for your spouse.
Here’s something else to keep in mind: Because Social Security taxes are based on your overall income, as described above, the amount of money you withdraw during retirement, and where that money comes from, can also affect your tax situation. For example, withdrawals from a traditional IRA are taxable and will increase your adjusted gross income, but withdrawals from a Roth IRA will be tax-free, provided you’ve had your account at least five years and you’re over 59 -1/2, so this money won’t enter into your taxable income calculations and it won’t increase the tax you owe on your Social Security benefits. Similarly, withdrawals from health savings accounts (HSAs) used for qualified health expenses also won’t count toward your taxable income.
By knowing exactly what to expect from Social Security, including the tax effects, you can more effectively incorporate your benefits into your overall retirement income planning – and the better your plans, the more you’ll be able to enjoy your life as a retiree.
[Arnetta Tolley, Financial Advisor Edward Jones Investments 626-744-2740 or Arnetta.firstname.lastname@example.org.]