Retirees Beware: The Surprising Tax Bite on Your Social Security Benefits

chuckstock /
chuckstock /

As you enjoy your golden years, understanding the tax implications of your Social Security benefits is crucial. While many retirees believe Social Security benefits are entirely tax-free, this isn’t always the case. The maximum amount that can be withheld from Social Security benefits in the US is 85% by the federal government. These include retirement, survivor, and disability payments (but not Supplemental Security Income).

Understanding Your Tax Liability
Having a large amount of taxable income from other sources, such as a job, pension, or conventional IRA, makes it more likely that your Social Security benefits will be taxed. However, if your only income is from Social Security, you may not owe federal income taxes on your benefits.

Each year, you’ll receive a Form SSA-1099 in January detailing the total benefits you received in the previous year. To assess whether your Social Security payments are taxable, you must compute your “combined income,” which comprises your adjusted gross income (AGI), nontaxable interest, and half of your benefits. After applying certain deductions and exclusions, you’ll fall into one of three tiers:

1. Tax-Free Benefits: Social Security benefits are not taxed for individuals or couples making less than $25,000 or $32,000 a year.
2. Approximately 50% of your benefits are taxable: If you earn $25,000 or more (single) or $32,000 or more (jointly).
3. Taxable at up to 85% if your combined income exceeds $34,000 (single filers) or $44,000 (joint filers).

Managing Tax Payments
If you want to avoid paying too much in taxes, you can ask the Social Security office to take federal income tax out of your Social Security funds by sending them Form W-4V. You could also pay a portion of your taxes every three months to include them in your monthly bills and avoid penalties for not paying enough.

State Taxes on Social Security Benefits
Some states tax Social Security benefits in addition to federal taxes. The ways and amounts of taxation change from state to state. For example, New Mexico taxes Social Security payments but lets people with higher incomes avoid paying those taxes. Missouri doesn’t tax Social Security benefits for people who file as single people and make less than $85,000 or $100,000 a year. This will end in 2024 when the state will no longer tax all Social Security retirement benefits.

What This Means for Gift Tax Limitations:
The government gifting tax, anywhere from 18% to 40%, is charged on all gifts and donations made during the year. This tax typically falls on the giver, but the recipient or the giver’s estate might bear this responsibility under certain circumstances. The tax encompasses more than just cash; it includes real estate, vehicles, forgiven debts, insurance policy benefits, and stock transfers. The value of these gifts is based on their fair market value at the time of the gift.

The 2023 Gift Tax Exclusion for Reference
In 2023, the annual gift tax limit was $17,000 per recipient, with a combined limit of $34,000 for married couples. These are the figures to refer to when filing taxes for the 2024 tax season.

Exceeding the Gift Tax Limit: What Happens?
If your generosity exceeds the annual gift tax limit, you may need to file a federal return using IRS Form 709. But if you exceed the monthly limit, you don’t have to pay tax immediately because of the large lifetime estate and gift tax exemption. For 2024, this exemption stands at $13.61 million (double for married couples), shielding most people from federal gift tax. Only when your cumulative gifts exceed this lifetime limit does the actual gift tax come into play.

Future Changes to the Lifetime Gift Tax Exemption
Looking ahead to 2026, the lifetime estate and gift tax exemption is expected to be halved and adjusted for inflation. This reduction could significantly impact wealthy individuals with large estates, potentially subjecting gifts made in 2026 and beyond to up to 40% gift tax. Gifts made before 2026, however, benefit from the current higher exemption.

Planning for a Tax-Efficient Retirement
Understanding and planning for taxes on your Social Security benefits is essential to retirement planning. You can also effectively manage your tax liabilities and maintain a comfortable retirement lifestyle by staying informed and making sound decisions.

Remember that everyone’s tax situation is different, so getting personalized help from a tax expert is always a good idea. Doing so can ensure you’re maximizing your retirement income and minimizing your tax burden.