The Strange Case of Taxing Your Social Security Benefits

Almost 62 million people, most of them retired workers, receive a Social Security check every month. That’s about 20% of all Americans these days and I’m one of them. For the vast majority of retirees, their Social Security income isn’t just some extra cash to count at the end of the month. It’s actually an indispensable source of income that they couldn’t do without. Social Security Administration (SSA) data shows that 62% of all retired workers get at least half their income, if not more, from Social Security. In some cases, it is the difference between life and death. And now that it’s tax time, many of us wonder “do you pay taxes on Social Security?”

Many seniors wonder "do you pay taxes on Social Security?" Well here is the strange case of how Social Security benefits are taxed and why it's unlikely to change.

The sad facts are that America’s most important social program isn’t in the best of shape. You probably know that Social Security will begin paying out more in benefits than it generates in revenue by 2022. By 2034, Social Security’s asset reserves are expected to be depleted.

There are some real reasons why this is occurring and one of them is the ever-demanding pressure placed on Social Security by the retirement of the “baby boomers” (guilty!). When the year 2034 rolls around, an across-the-board cut in benefits of up to 23% may be needed to extend payouts through the year 2091. So guess what? Even if you aren’t a baby boomer, planning to retire this year or next year or even in 40 years from now, the dilemma and strange case of Social Security is going to affect you if something isn’t done to fix it.

Believe It or Not We’ve Been Taxing Social Security for 35 Years

Social Security benefits were first subject to income tax in the Social Security Amendments Act of 1983 under President Reagan. This tax was part of a broader package designed to raise revenue and cut long-term costs for the Social Security program.

Beginning in 1984, up to one-half of Social Security benefits became taxable income for taxpayers whose adjusted gross income (AGI), combined with half their benefits and any tax-exempt interest exceeded $25,000 for a single taxpayer and $32,000 for married taxpayers filing jointly.

In plainer English, earning above these thresholds allowed the federal government to expose up to half of a beneficiary’s Social Security benefits to ordinary income tax. The move was expected to affect around one in ten beneficiary households.

But Wait, It Gets Worse!

To make the situation even more of a burden for SS recipients, in 1993 the Clinton administration added a second tier of taxation that allows up to 85% of a beneficiary’s Social Security income to be federally taxed. In order for this tier to apply, single taxpayers would have to have an AGI above $34,000, with couples filing jointly above $44,000.

Now that you understand why there’s a tax and who is taxed, let’s get into the nitty-gritty of why the taxation of benefits has created such a strange dilemma.

Should We or Can We Eliminate the Tax?

On one hand, eliminating the taxation of benefits makes sense. After all, retired beneficiaries who earn more than the income thresholds are essentially having to hand money back to Uncle Sam that was, in their minds, already taxed while they were working and it was collected. If this tax were eliminated, middle-income retired workers would see a difference in their AGI and taxes, putting these folks on a more firm financial foundation.

To boot, the income thresholds associated with the taxation of benefits haven’t been adjusted for inflation once in the past 35 years. This tax that had once affected around just 10% of households now impacts 56%, with this figure expected to move even higher as time passes. The tax is hitting households that it was never intended to impact, which is a pretty good reason to can this tax.

But…and It’s a Big But

There’s that not-so-tiny problem known as Social Security’s $12.5 trillion budget shortfall between 2034 and 2091. If the taxation of benefits were removed, around 3% of Social Security’s annual revenue would then disappear. In 2016, the taxation of benefits was responsible for $32.8 billion (3.4%) of collected revenue. Without this channel of revenue, Social Security’s asset reserves would likely deplete even faster than already forecast.

Now, in addition we have the new tax law that President Trump recently signed which is expected to increase the federal deficit by $1.5 trillion over the next decade (according to the Joint Committee on Taxation). The federal government needs as much tax revenue as it can get, which means not only ensuring that the taxation of SS benefits remains on the table, but also leaving the 35-year-old thresholds in place without adjusting them for inflation.

Multiple Income Streams Can Protect Your Retirement

When looking at the dangerous condition of the Social Security program, it makes even more sense than ever to prepare for retirement with alternate/multiple sources of income to protect you when you are no longer working or able to work.

That means, number one, make sure you are investing in a retirement plan at work to the maximum (401(k) being the most common) and when matching (free) funds are available, get every penny. If your employer doesn’t offer this kind of plan, then open an IRA on your own.

You should also consider other sources of income, possibly real estate or investing in stocks and bonds. Of course, doing any of these should be based on your income, future needs, and your risk tolerance at your current stage of life.

My Own Retirement Income

In my case, besides my monthly SS check, I also prepared for retirement with investing in my 401(k) during all of my 40+ years of work. When it’s necessary, I draw some money from that account although not every year. When I turn 70½ that draw will become a requirement.

In addition, as I wrote about last October, I am now getting a pension from my days with R.H. Macy’s, which I admit I had completely forgotten about (don’t let that happen to you!).

Besides working at the NJ election polls twice a year (yes I get paid for that!), I also make a small income from this blog which is a source of pride more than wealth. And I make sure that I take advantage of every tax rebate, refund, and incentive I can qualify for each year like the Earned Income Credit (EIC), Senior Real Estate Tax Freeze (NJ), and Homeowners Real Estate Tax Rebate (NJ).

That along with all of the other ways I find as sources of income from credit card bonuses and rewards, investment income, interest income, and of course my obsession with saving money on everything I purchase if possible, makes my total income workable.

Retirement Planning

The older you are right now, the more conservative it is recommended you will need to be when it comes to investment alternatives. My investment income is about as conservative as you can get. Although you want to make sure that your investments aren’t losing money when you account for inflation.

Keep in mind, when you are retired, certain expenses in your life will be reduced like commuting expenses and clothing costs. But, there may be severe increases in other areas like healthcare as one very significant expense among retired folks.

When looking at your financial needs in retirement, you have to look at the lifestyle you want and can afford and that isn’t an easy task. Some guesstimate and margin for error on the higher expense side is a good way to over prepare for your golden years!

Final Thoughts

Higher income now for middle-income seniors, the elimination of an archaic tax, or the quicker depletion of the program’s asset reserves, assuming Congress makes no changes to how the program generates income, that’s the conundrum and makes solving the strange case of Social Security one for the likes of a Sherlock Holmes…

What do you think should be done? You will be getting your Social Security benefit at some point—if it still exists. What other income will you have after you retire? If you haven’t prepared for the worst, you might just be in serious trouble. What should be done about the Social Security conundrum?


    1. Keep in mind that only a portion of Social Security is taxed when you have an AGI that’s above the thresholds. You’d have to have a pretty large income after retirement to pay the maximum taxes. Usually retirees, if they have to pay, pay only a small amount. One way to prepare, Jamie, is to try to project what income you might have after you retire and it will give you a better idea if the tax is in your future.

  1. Oh, wow, I didn’t know this was a thing. That’s pretty messed up as it does feel like double taxation.

    Also upsets me that we’re staring down this problem while corporations just got a huge and permanent tax break. How backwards is it that citizens are likely to not see (all/some of) the money they’ve contributed while this is happening? I hope something changes to rectify the situation–without cutting social security or other important programs.

  2. Lots of people wonder if SS will still exist. I can’t imagine that any politician could get away with eliminating it. Yes, it will have to be financed in some other way, but the idea that we can’t retire on SS just won’t play well with the masses.

    1. My biggest fear, RAnn, is that cuts will be made in the benefits and with the way people have not been preparing for their retirements, it would wreak havoc. I don’t think there’s a danger that it would be discontinued, but it is important that people think about other sources of income because of the uncertainty of the programs.

  3. Anon

    This is in response to Jamie. It’s very important to include taxes in your retirement planning. People that delay claiming their SS until 70 and also have to take RMDs will be surprised at how much more they will be paying in taxes then.

  4. Mary Bessman

    My dilemma: You need to know AGI in order to calculate amount of taxable social security but you need to know amount of taxable SS in order to calculate AGI. I must be missing something

    1. You don’t need to know the AGI to calculate your Social Security taxable income. In fact, you calculate your SS taxable income to help determine your AGI!

      There are several variables that determine the amount of your taxable Social Security benefits and you can calculate that amount yourself once you have your income facts. That leads to your adjusted gross income (AGI).

      Step 1: What is your Provisional Income? – “provisional income” includes half of your Social Security benefits, plus all other taxable income like a traditional IRA distribution, dividends, realized interest, and realized capital gains, or other taxable earnings.

      Step 2: Use the “First Threshold” – Subtract the first threshold from your provisional income and multiply by 0.5 (for an individual, your combined income thresholds are between $25,000 and $34,000 so you would subtract $25,000 and then multiply, or use the threshold for a married couple filing jointly of between $32,000 and $44,000 and subtract the $32,000 and then multiply). FYI, filing separately while married is not helpful and will increase your taxes according to the Social Security website.

      Step 3: Next calculate with the “Second Threshold” – subtract the second threshold from your provisional income (if single use $34,000 and if married filing jointly use $ 44,000) and then multiply by 0.35.

      Step 4: Add the 2 answers together.

      Step 5: Next, calculate the maximum tax by multiplying your total SS benefits received by 0.85. If your answer in Step 4 is less than the maximum tax then that is the portion of your SS benefits that will be taxed and entered on line 5b on the 1040 tax form. If Step 4 is less than the maximum you calculated in Step 5 then the maximum tax will be entered on line 5b and that taxable amount is added to your AGI on line 22.

      I hope this helps!

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