Don’t let a smaller Social Security check catch you off guard.
The average retired worker collecting Social Security today gets about $1,917 per month. But that doesn’t mean your monthly benefit will be similar.
The amount of money you’re eligible for from Social Security will hinge on a combination of your lifetime wages and the age at which you sign up for benefits. If you wait until full retirement age, you’ll get your complete monthly benefit based on your personal income history. But if you file sooner, your monthly paychecks will be reduced. On the flipside, you can boost your monthly Social Security benefit by delaying your filing until the age of 70.
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It’s a good idea to try to get an estimate of your monthly Social Security benefit ahead of retirement. And the easy way to do so is to create an account on the Social Security Administration’s website and access your annual earnings statements, which will present that number to you.
Of course, the closer to retirement you get, the more accurate those benefit estimates may be. But still, the amount of money you actually get from Social Security may end up being smaller than expected, and it’s all because of one frustrating rule.
Did you know that taxes apply to Social Security?
Many people assume that the monthly benefits they’re entitled to from Social Security are theirs free and clear of taxes. And sometimes, that is the case.
Typically, you won’t pay taxes on your Social Security benefits if they’re your only source of retirement income. And you might avoid those taxes if you have very little income outside of your monthly benefits. But once you have even a modest amount of income on top of Social Security, taxes begin to come into play.
Whether your Social Security benefits will be taxed or not in retirement hinges on your combined or provisional income. That’s calculated by taking half of your annual (not monthly) Social Security benefit and adding in additional income you receive, including tax-free interest you may get from investments like municipal bonds.
The problem is that the thresholds for combined income are pretty low in the context of Social Security benefits being taxed. If you’re a single tax-filer and your combined income exceeds the $25,000 mark, taxes on benefits start to apply. The same holds true for joint tax-filers with a combined income of $32,000.
For this reason, a lot of people inevitably wind up seeing their benefits taxed. One savvy move on your part, though, might prevent that scenario.
How to avoid taxes on your Social Security checks
What often pushes people into being taxed on their Social Security is having outside income in the form of IRA or 401(k) plan withdrawals. But if you house your retirement savings in a Roth IRA or 401(k), you may not end up getting taxed on Social Security. And the reason is that Roth withdrawals don’t count toward combined income because they’re not considered taxable income.
So, let’s say you’re single with a monthly Social Security benefit of $2,800, leaving you with $33,600 per year in total. Half of that is $16,800, which puts you pretty close to the $25,000 threshold where taxes on those benefits might apply.
However, if your only other retirement income source is a Roth IRA, you can withdraw however much you like, and it won’t be added into your provisional income. As a result, your Social Security benefits may be yours to enjoy tax-free.
Of course, it would be nice to see these super-low combined income thresholds increased given that they’ve been in place for decades with no adjustment. But lawmakers don’t seem to be in a hurry to make changes in that regard.
So if you want to avoid being taxed on your Social Security benefits and winding up with less money from the program as a result, aim to save for retirement in a Roth account. That’s a smart thing to do for the tax-free income alone.