Here’s Why You Might Lose a Chunk of Your Social Security Benefits

Even if you save a nice amount of money for retirement during your career, there's a good chance you'll depend on Social Security to some degree during your golden years. Maybe those benefits will be used to pay your rent, maintain your car, or travel like you've always dreamed of doing.

The good thing about Social Security is that you can estimate your benefits ahead of retirement by creating an account on the Social Security Administration's (SSA) website and checking your earnings statements. The closer you are to retirement, the better the SSA will be able to estimate what your monthly payments will look like.

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Of course, the age at which you claim benefits will impact the amount you collect, too. If you file at full retirement age, which is either 66, 67, or somewhere in between, depending on your year of birth, you'll get the exact monthly benefit your earnings history entitles you to. If you file at any point before full retirement age (you can claim benefits as early as 62), you'll get a lower monthly payment. And if you delay benefits past full retirement age, you'll boost them by 8% a year up until age 70.

Once you get a sense of what your Social Security benefits will amount to, you'll be able to create a retirement budget that factors them in. But if you're not careful, you might forget one key aspect of Social Security that causes seniors to wind up disappointed year after year: taxes.

How Social Security is taxed

If Social Security is your only source of retirement income or your primary source, then you may not have to pay taxes on your benefits. But if you have other income, like retirement savings, a pension, or earnings from investments or a job, then your benefits may be subject to federal taxes.

To see if your benefits will be taxed, you'll need to calculate what's known as your provisional income. That figure is essentially your non-Social Security income plus 50% of your Social Security benefits for the year. If your total is between $25,000 and $34,000 as a single tax filer or between $32,000 and $44,000 as a joint filer, then you could be taxed on up to 50% of your benefits. And if your total exceeds $34,000 as a single tax filer or $44,000 as a couple filing jointly, then you could be taxed on up to 85% of your benefits.

Aside from federal taxes, the state you live in will dictate whether or not your benefits are taxed. There are 13 states that tax Social Security to different degrees:

  • Colorado
  • Connecticut
  • Kansas
  • Minnesota
  • Missouri
  • Montana
  • Nebraska
  • New Mexico
  • North Dakota
  • Rhode Island
  • Utah
  • Vermont
  • West Virginia

Most of the above states offer some type of exemption so that you can get out of paying taxes on your benefits if you're not a particularly high earner. Minnesota, North Dakota, Vermont, and West Virginia, however, offer no exemption along these lines.

Prepare to pay

Though there are things you can do to lower your tax burden in retirement, for the most part, it's hard to avoid paying federal taxes on Social Security once your income hits a certain threshold. And while you could technically relocate to a different state that doesn't tax Social Security, if yours has the opposite practice, keep in mind that it's not worth subjecting yourself to a higher cost of living in an effort to get out of paying what could be a relatively small amount of tax on your benefits.

Your best bet in managing your Social Security income is to be aware of the taxes you may get hit with and budget around them.

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