Social security income is taxable. However, the amount of your social security income dictates whether or not to pay social security tax. For instance, if you have an additional source of income like a 401(k), then your social security benefits are taxable. However, if you only rely on your social security benefits, then you don’t need to pay tax on your social security benefits.
What is Social Security Tax?
Social security is the money that the government withholds from your earned income. Once you retire, this money is used to pay for your retirement benefits. You contribute to the social security kitty when you are working and then enjoy its benefits when you retire.
How is Social Security Financed?
Social security is financed through a payroll tax payable by both employers and employees. Each pays 6.2% of the wage income up to the maximum threshold of $147,000. However, for those that are self-employed, they pay 12.4%.
How Do Social Security Taxes Work?
If you are an individual earning more than $25,000 or a couple filing tax returns jointly and earning more than $32,000, then your social security benefits are liable to taxation. Your employer pays 6.2% while you also pay the same amount making a total of 12.4%. Those who are self-employed pay 12.4% of the social security tax.
The amount paid by employees and employers is directed to the Social Security Trust Funds. The money is used to pay for retiree benefits. You contribute to the social security fund while you are working. The amount you contribute while working is used to pay other retirees' security benefits. When you retire, current workers will contribute to your social security benefits. This way, the social security system is able to sustain itself.
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How Much of Social Security is Taxable?
Social security benefits are only taxed if they are above a certain income limit. If you receive social security and you have other sources of income, then you have to pay tax on your social security benefits.
If you file your tax returns individually, then your income of:
- Between $25,000 and $34,000 will be taxed up to 50% of your benefits
- More than $34,000 will be taxed up to 85% of your benefits
If you are married and file your tax returns jointly, then your income of:
- Between $32,000 and $44,000 will be taxed up to 50% of your benefits
- More than $44,000 will be taxed up to 85% of your benefits
Is Social Security Disability Taxable?
Yes. Social security disability is taxable. However, most of the beneficiaries don’t pay it since they don’t have other sources of income. Others do pay the social security disability tax because of their spouse’s income or other sources of income.
If you are married and you file your tax returns jointly and you have more than $32,000 annual income, inclusive of SSDI benefits, then your SSDI benefits are subject to taxation. If you are single and you earn more than $25,000 annually inclusive of SSDI benefits, a percentage of your SSDI benefits are subject to taxation.
Can You Avoid Social Security Tax?
Yes. There is a certain class of people that are exempted from social security tax. For instance, nonresidents, students, or employees of foreign governments don’t have to pay social security tax. However, these people can’t receive social security benefits in the end. The amount of money you have contributed to the social security system determines your social security benefits.
How to Minimize Tax on Social Security
This is how you can avoid social security tax:
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1. Reduce Business Income
To reduce social security tax, you need to minimize business income or partnership income. You can do this by increasing business expenses.
2. Minimize Withdrawals from Retirement Plans
When you withdraw money from a traditional 401(k), it will be deemed as income in the year you withdraw it. By not withdrawing that money, it helps you get close to the tax-free threshold where your benefits won't be taxed.
3. Move Income-Generating Assets into an IRA
When you direct income-generating assets into an Individual Retirement Account (IRA), their interest and dividends won’t be considered as income immediately. IRAs have tax sheltering advantages and gains won’t be taxed until the asset is sold.
4. Donate the Required Minimum Distribution (RMD)
The other way to avoid social security tax is by donating RMD to charity. By so doing, you will get to a tax-free zone. However, you must be over the age of 72 and the donation must be directly from the IRA.
5. Take the Maximum Capital Loss
This method is also called tax-loss harvesting. You can write off up to $3,000 each year you make a loss in your investments. This write-off lowers the capital gains you have earned in that year. Any loss beyond $3,000 can be carried forward to the future years. This strategy works with taxable accounts and not with tax-advantaged accounts like IRA.
Summary of Social Security Tax and How it Works
While everyone wants to reduce the social security tax, it is also good to put things into perspective. You need to make good financial moves that will increase your after-tax income. Don’t just aim at minimizing tax, but also consider other gains. For instance, it would be best if you can find ways to maximize your social security benefit instead of minimizing your social security benefits.