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Social Security benefits are an important source of income for many Americans. Initially, these benefits were exempt from taxation. However, since 1983, those benefits can be subject to income tax under certain circumstances.
Social Security provides over 50% of Americans’ retirement income, but many retirees have other sources of income outside of Social Security. For those with additional income, understanding the concept of provisional income and how it is calculated can be an important step in minimizing their tax burden during retirement.
How to Calculate Provisional Income
The calculation for provisional income is rather simple. Start with your adjusted gross income [AGI] from your tax return, excluding Social Security benefits. This figure could include wages, self-employment income, pension benefits, dividends, interest, or any other form of taxable income.
Next, add interest income that is nontaxable at the federal level, such as municipal bond interest or assets inside a Roth retirement account. Finally, add one half of social security benefits from your Form SAA-1099. Keep in mind, married couples should include income from both spouses.
When this calculation is complete, the result is what the Social Security Administration calls “combined income”, otherwise referred to as provisional income.
How Provisional Income Affects Taxation
Similar to the income tax system, there are cutoffs for provisional income that affect the taxation of Social Security benefits at different levels of income. These magic numbers are $25,000 and $34,000 for individuals, and $32,000 and $44,000 for joint filers.
Reaching either of those two income cutoffs greatly increases the tax exposure of an individual’s or couple’s Social Security benefits. The respective tax burdens are:
- 0% for those individuals who have provisional income below $25,000 ($32,000 for joint filers)
- up to 50% for individuals who have provisional income above $25,000 but below $34,000 ($32,000 to $44,000 for joint filers)
- up to 85% for individuals who have provisional income above $34,000 ($44,000 for joint filers)
Calculating Your Tax Burden for Social Security Income
Calculating your individual tax burden for Social Security income is a bit more involved. But for those in the middle category listed above, it looks something like this:
The amount of income to include is the lesser of:
- 50% of the annual Social Security benefits received, or
- 50% of the excess of the filer’s provisional income, over the threshold.
Detailed examples on how to calculate the tax burden for Social Security income can be found at the IRS website.
Work with Meld Financial to develop your FINANCIAL FINGERPRINT™.
Social Security planning can be a very complicated endeavor. However, the financial planners at Meld Financial can leverage their vast experience, in conjunction with a team of financial and legal professionals, to help you develop your FINANCIAL FINGERPRINT™.
Your FINANCIAL FINGERPRINT™ is a unique planning process developed here at Meld Financial during several decades of managing our clients’ wealth. In short, your FINANCIAL FINGERPRINT™ is a plan that is quick to assemble, easy to understand and simple to modify as your circumstances change.
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