Social Security benefits have been an important source of income for Americans since the Great Depression. Initially, these benefits were exempt from taxation. However, a 1983 law made benefits subject to income tax for some individuals with other sources of retirement income.
The calculation to determine whether your Social Security benefits are taxable is called ‘provisional income.’ By understanding how to calculate this figure, you can better plan for taxes in retirement and work to minimize these expenses.
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. Finally, add one half of the 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 thresholds 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 levels 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 between $25,000 and $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)
Unlike most types of U.S. taxation, the provisional income levels are not adjusted for inflation each year. They only change when Congress acts to raise them.
Calculating Your Tax Burden for Social Security Income
Calculating your individual tax burden for Social Security income is a bit more involved than determining your provisional income. For those in the middle category listed above, taxable benefits are 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. For more personalized guidance, work with a financial advisor who has vast experience with Social Security and tax planning.
Using Your Provisional Income to Minimize Your Tax Burden
Income taxes can greatly reduce your retirement income and in some cases a high tax burden can keep you from living the retirement of your dreams. That’s why it is important to have a plan in place for managing taxes during your retirement years.
The first step in an effective tax plan is to forecast your future tax burden, starting with your provisional income. Then, you can work with a group of experienced financial professionals to find ways to minimize the amount you owe.
Work with Meld Financial to Minimize Taxes in Retirement
At Meld Financial, we can help you determine how taxes fit into your retirement plan. Then, our team of tax, legal, and investment professionals can offer solutions for minimizing your tax burden that are tailored to your specific situation.
In addition to helping you minimize taxes, our financial planners can leverage their vast experience to develop your Financial Fingerprint®. This comprehensive wealth management program brings the most important aspects of your financial situation together in one easy to understand plan.
With your Financial Fingerprint™, and an ongoing relationship with an experienced financial advisor, you can turn your dream retirement into a reality. Contact us today to get started with Financial Fingerprint®.
