Why Social Security Is Key To Your Tax Strategy if Retired (or Soon To Be)
You might think that hitting retirement age and collecting Social Security benefits frees you from the grind of filing income tax returns, but that’s not the case. If your only income for the year came from Social Security benefits, then your benefits are usually not taxable and you technically don’t need to file a federal income tax return. But there are reasons you should file anyway as part of a smart tax strategy.
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The first thing to know is that you might be required to file federal income taxes even if you collect Social Security. This is the case if you still earn outside income and your provisional income hits a certain threshold.
For single tax filers, Social Security benefits aren’t taxed if your provisional income is less than $25,000. That rises to $32,000 if you’re married and filing a joint return. Up to half of your Social Security benefits might be taxable if your provisional income is $25,000 to $34,000 for single filers, or $32,000 to $44,000 for joint filers. Anything above those income levels, then up to 85% of your benefits could be taxable.
Even if you don’t earn outside income, there are other things you need to keep an eye on tax-wise. For example, if you withdraw a large amount of money from a bank or other account you could face a significant increase in the percentage of your Social Security benefits that will be taxed, the AP reported
“A $20,000 capital gain might cause an equal amount of Social Security income to be taxable,” Tom O’Saben, director of tax content and government relations at the National Association of Tax Professionals, told the AP.
Withdrawing from a 401(k) or other retirement account too early could also result in penalties or taxes owed, which is something you need to pay attention to as you approach retirement age.
The good news is that if you are over age 50, you can make catch-up contributions to your traditional or Roth IRA. Catch-up contributions to an IRA are due by the tax return deadline, so you have until Tax Day this year to make contributions for last year. These contributions are designed to help you catch up on your retirement savings later in life.
Another good idea is to take IRA or 401(k) withdrawals before claiming Social Security, AARP reported. This would apply if you have reached age 62, which is the earliest you can apply for benefits. “Taking distributions from tax-deferred retirement accounts will reduce your balance, thus reducing the size of your future [required minimum distributions]. It can also help you delay claiming Social Security benefits, which means you will get a higher monthly payment.
In terms of smart tax strategies for Social Security recipients, another thing AARP recommended is prioritizing distributions from a tax-free retirement account such as a Roth 401(k) or Roth IRA rather than a traditional retirement account. This helps you avoid paying taxes on the withdrawal.
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This article originally appeared on GOBankingRates.com: Why Social Security Is Key To Your Tax Strategy if Retired (or Soon To Be)
