Social Security and Tax Issues in Retirement

(7 of 8)

Social Security and Tax Issues in Retirement

Social Security as presently constituted is a guaranteed, inflation-adjusted lifetime annuity. Sure, it can be tempting to take Social Security as early as possible—age 62. But the payout is lower at the younger age, and you will leave a lot of money on the table—unless you’re sure you are going to die young. Even then, however, what about the value of spousal benefits if your spouse outlives you by many years?

To maximize your Social Security income

To avoid losing Social Security to either income tax or through lowered benefits, many experts advise those planning to stay on the job to delay taking their Social Security for as long as possible. The longer you wait, the higher the monthly payout.

Your benefits will increase each year until you reach age 70. So if you continue working, you can get the most out of your benefits by waiting until then to begin taking Social Security. But at age 70, the payment to which you’re entitled is maxed out, so it makes no sense to delay beyond then.

You can work while receiving Social Security

Of course, you can work while you receive Social Security retirement (or survivors) benefits. Some people will find this results in a higher benefit for you in the future. Higher benefits can be important to you later in life and increase the future benefit amounts your family and your survivors could receive.

When to begin drawing on it

A consultation with a financial planner can be very helpful in evaluating the best time for you to begin drawing Social Security. Many planners look at the break-even age: If you start at 62 you receive a lower stream of payments, but you get it for more years, compared to starting at 70, when you’ll get a higher amount, but for fewer years.

So when does the cumulative total of the age 70 benefit exceed the total you’d get from applying at 62? Typically it’s around age 78. So many advisers ask about your family and personal life expectancy. To put it bluntly, do you think you’ll make it past 78? If so, other factors aside, it’s probably wise to stay in the workforce if necessary to avoid resorting to Social Security prior to age 70.

Be sure to include an attorney in your Social Security decision-making process, as financial planners and advisors cannot give legal advice regarding Social Security.

Tax issues to consider

This is likely to be so even if it results in the need to draw more money out of your tax-deferred retirement savings such as a 401(k) or IRA. That is, it’s often better to do just that—pay income tax on the withdrawal and to delay taking Social Security. Remember, too, that you must begin tapping that IRA at around age 70 anyway, and the higher the account balance, the greater will be the annual minimum required distribution, as well as the tax on that greater distribution. In other words, by not drawing upon your IRA sooner rather than later, you might wind up having to take out more money from it each year than you need, at a greater overall tax cost.

Bottom line: In a great many scenarios, you will be better off using a combination of retirement employment and tax-deferred savings to live on while delaying your Social Security benefits until age 70.

Another reason to keep working

Another factor to consider is that your Social Security benefit is calculated by averaging your earnings in your 35 highest-paid working years. If your work history did not cover 35 years, the average will include zero earnings for the years you did not work, resulting in a lower benefit.

Therefore, if going back to work replaces zeros or low-earning years with higher-earning years, then your benefits will go up. You can check your earnings history in the Social Security statement that is available to you online at www.ssa.gov.

While you are working, your earnings will reduce your benefit amount—but only until you reach your full retirement age. After you reach full retirement age your Social Security benefit is recalculated, leaving out the months when you received reduced benefits due to your excess earnings.

Social Security uses a formula to determine how much your benefit must be reduced: if you are under full retirement age for the entire year, $1 is deducted from your benefit payments for every $2 you earn above the annual limit. For 2025, that limit is $23,400.

Starting with the month you reach full retirement age, you can get your benefits with no limit on your earnings.

More tax stuff

Note that full retirement age had been 65 for many years. However, beginning with people born in 1938 or later, that age gradually increases until it reaches 67 for people born after 1959. There is an online calculator you can use to enter your date of birth and find your full retirement age. For more information see the Social Security Retirement Planner page.

When to pay tax on your Social Security income

You will have to pay federal taxes on your Social Security benefits if you file a federal tax return as an individual and your total income is $25,000 or more. If you file a joint return, you will have to pay taxes if you and your spouse have a total income of $32,000 or more. Above those limits, up to 85 percent of your benefits are subject to income tax.

Use the Internal Revenue Service (IRS) Notice 703 shown on the back of the Social Security Benefit Statement, SSA Form 1099, to determine if any of your benefits may be taxable.

For complete information on the taxation of Social Security benefits, see IRS Publication 915.

Finally, remember that Social Security does not withhold state or local taxes from your benefit. Fortunately, many states and local authorities do not tax Social Security benefits, but if you live in a place where they are taxed, you should be prepared for the tax hit and plan accordingly.