Your Social Security check may be taxed. How could this change
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Death and taxes are two certainties in life, as they say.
But many people may not realize that the Social Security benefits they receive from the government are also subject to taxes.
The way these levies are applied is unique.
A recent MassMutual quiz revealed that only 42% of 1,500 respondents close to retirement were able to correctly identify whether the following statement is true or false: “Social Security retirement benefits are subject to income tax, just like withdrawals from a traditional system [individual retirement] Account.”
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The answer is wrong.
In fact, Social Security benefits and IRA withdrawals are not treated the same under tax rules.
There is no limit on the income you must report from an IRA. But there is a ceiling for social security benefits.
“It’s not well understood,” said Nancy Altman, president of Social Security Works, a social welfare organization, of benefit taxes.
How Social Security Contributions Work
The fact that levies are applied to benefits is “extremely unpopular,” Altman said. “People hate it, but it actually makes political sense,” she said.
One of the main reasons this is good policy is that Social Security benefits and private pensions are taxed the same way.
When the program was created in 1935, benefits were not taxed. This began to change in 1983, when Congress changed the rules so that up to 50% of Social Security benefits could be included in taxable income, if a taxpayer’s income exceeded certain thresholds.
Further changes took place in 1993, raising the share of certain social security benefits subject to tax to 85%. This change applied to higher income beneficiaries.
The result is a complicated set of rules that still apply today.
First, taxes are based on what is called provisional or combined income. This includes half of your Social Security benefits plus your adjusted gross income and tax-free interest. This means that any income from wages, interest, dividends or other taxable income is taken into account.
Then the 50% and 85% thresholds are applied.
People with a combined income between $25,000 and $34,000 will pay income tax on up to 50% of their benefits. This also applies to couples with incomes between $32,000 and $44,000.
Individuals with a combined income of more than $34,000, as well as couples with more than $44,000, may pay tax on up to 85% of their benefits.
These thresholds are not indexed, meaning they have not been updated since they were first established by Congress.
As a result, over time, more and more people became subject to tax on their benefits.
“The intention was that it would only affect high-income people when it was first adopted in 1983, but over time it has increasingly reached the middle class,” Joe said. Elsasser, founder and president of Covisum, a provider. social security claim software.
If your income is below the thresholds, your benefits are generally not taxed, he said. But for high earners, the levies are more like a cut in benefits.
Tax revenues flow directly into social security trust funds.
How Taxes on Benefits May Change
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Social Security trust funds are running out. The federal agency predicted last year that they could be exhausted by 2034, by which time 78% of benefits will be payable.
Lawmakers have several options to shore up the program. They can raise the retirement age. They can also increase payroll taxes.
When they eventually consider changes, reevaluating how benefits are taxed will also likely be on the table, according to Jason Fichtner, chief economist at the Bipartisan Policy Center.
According to Fichtner, the taxation of benefits is a kind of back door that has the effect of reducing benefits for people of a certain level of wealth or assets.
Congress could adjust income levels or percentages for high earners, while ensuring that those with lower benefits are not affected by these changes, he suggested.
According to Elsasser, these changes can be executed in different ways.
Congress can replace the current two thresholds with a higher threshold in which 85 cents on the dollar or the whole dollar is taxable.
Additionally, they could choose to eliminate the provisional income calculation and count all income within the thresholds.
These types of adjustments may be more palatable to political leaders on both sides of the aisle compared to other options.
“Saying I’m going to cut your benefits doesn’t sell politically,” Fichtner said. “But to say we’re going to tax the wealthiest people on their benefits is probably more politically feasible for Republicans to sign.”