by Ryan McKeown, CPA, CFP®, Associate Financial Advisor, Wealth Enhancement Group

A common misconception made when planning for retirement is that Social Security Benefits are not subject to income tax, but for the majority of people receiving Social Security Benefits they will be. Social Security Benefits are not automatically subject to income tax; they are only subject to income tax based on a formula that takes into account various income sources, some of which are not taxable.
 
If you file single or head of household, and your “combined” income is between $25,000 and $34,000, up to 50% of benefits are taxable. If “combined” income is above $34,000, 85% of benefits are taxable. If you are married filing jointly and your “combined” income is between $32,000 and $44,000, up to 50% of benefits are taxable. If your joint “combined” income is above $44,000, 85% of benefits are taxable. “Combined” income is the sum of your Adjusted Gross Income, plus nontaxable interest, plus half of Social Security benefits.
 
For example:  you are married filing jointly, receiving a combined $24,000 in Social Security Benefits. Your benefits aren’t taxable if that was the only income source you have because one half of your benefits do not exceed $34,000.  However, let’s say that you also withdrew a taxable distribution from your IRA of $24,000. One half of your benefits ($12,000) plus your IRA distribution total $36,000, making your combined income $4,000 over the point where your benefits become included in taxable income. In this case, 50% of $4,000, or $2,000 would be considered the taxable portion of your benefits. The key planning pointer to make is that not only are you paying income taxes on the $24,000 you withdrew from your IRA, but because you withdrew so much from your IRA, you now have to pay taxes on $2,000 of your Social Security Benefits as well. 
 
There are several strategies to reduce the amount of Social Security Benefits that are taxable, however, everyone has a different situation and should consult with their tax advisor as to what would be an appropriate course of action.