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Will Your Social Security Benefits Be Taxed? By Anita Srivastava

Updated: Jan 14, 2019

For many people, the answer is yes – but these strategies from Merrill Lynch Wealth Management could help you minimize the hit on your retirement income.

AFTER YEARS OF PLANNING for that perfect retirement—diligently investing their money, drawing up detailed budgets and investing assets wisely—many investors continue to miss one important detail. As much as 85% of your Social Security income could be subject to federal (and possibly state) income taxes.

“That can be a real shock when people collect their first check,” says Bill Hunter, a director of personal retirement strategy and solutions at Merrill Lynch.

How much of your Social Security income is subject to tax depends on a variety of factors, including your federal income tax filing status and modified adjusted gross income. But with a little up-front planning, you may reduce the possibility of taxes derailing your plans.

How Taxes Are Calculated Social Security benefit taxes are based on what is commonly referred to as your provisional income. That includes half of your Social Security income for the year, plus your modified adjusted gross income, which includes (among other items) certain tax-exempt income—such as income from municipal bonds, often a core component of retirement portfolios. After you cross the income threshold—$25,000 if you file as single, or $32,000 for married couples filing jointly—a portion of your Social Security benefits will be considered taxable income, explains Marcus U. Jean-Simon, a Merrill Lynch director and Goals-Based Consultant. For example, a couple in retirement filing jointly with provisional income of at least $32,000 could find that up to 50% of their benefits are considered taxable income.

A Longer-Term Strategy

Because of these income thresholds, tax planning experts often advise looking for ways to lower your provisional income. "When you plan for retirement, you need to think in terms of multiyear projections," says Vinay Navani, a shareholder with Wilkin & Guttenplan, an accounting and consulting firm in East Brunswick, NJ. For example, if you anticipate a big one-time event such as the sale of a business, you may be better off structuring it as an installment sale to be paid off over several years instead of an all-cash transaction. This can help evenly distribute your overall income and possibly keep you in a lower tax bracket, which could help minimize that tax hit on your Social Security benefits.

You may also want to consider a longer-term strategy for drawing from your qualified retirement accounts. That is because withdrawals from a traditional IRA generally will be included in your provisional income calculations. Qualified withdrawals from a Roth IRA, however, generally are not included. So, if you have both, you may want to carefully consider whether you should make withdrawals from your Roth or traditional IRA first.

Know the Penalties

Those hoping to work in retirement need to be especially careful if they are planning to claim Social Security benefits early.

The Social Security Administration (SSA) caps how much you are allowed to earn if you start taking your benefits before full retirement age, which the SSA considers 66 for most baby boomers. In 2017, the annual earned income cap is $16,920, and for every $2 you earn over that limit, the SSA trims $1 off the top of your benefits. So if you earn $20,000 this year, and you have not yet reached full retirement age, your benefits will be reduced by $1,540—on top of any income taxes you may have to pay on the remaining benefits.

There is some good news, however: Because the penalty is determined by your individual earned income, if you retire early and your spouse does not, and if you file separately, your spouse's earned income will not be factored into any benefit cuts that could apply. However, if you file jointly, your spouse's earnings will be included when calculating your provisional income. Additionally, when you reach your full retirement age, the earned income penalty disappears.

Forewarned Is Forearmed

Lastly, do a bit of homework. Worksheets in IRS Publication 915, “Social Security and Equivalent Railroad Retirement Benefits,” available at, can help you compute your tax liability. Then check with your state to see whether it taxes benefits. You might not be able to avoid taxes, but at least you will know what to expect and will be able to plan accordingly. As always, your financial advisor can work with your tax professional to find appropriate solutions.

Anita Srivastava is a Wealth Advisor at Merrill Lynch in Glen Rock, NJ.

Anita Srivastava is a Wealth Advisor at Merrill Lynch in Glen Rock, NJ. The information contained in this article is not a solicitation to purchase or sell investments. Any information presented is general in nature and not intended to provide individually tailored investment advice. The strategies and/or investments referenced may not be suitable for all investors as the appropriateness of a particular investment or strategy will depend on an investor's individual circumstances and objectives

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