Most people do not really understand how Social Security works. It is estimated that about 52 percent of recipients of Social Security benefits may have to pay taxes on the benefits.
According to the Social Security Administration and the IRS, if a person earns less than $25,000, they are tax exempt. For an individual earning between $25,000 and $34,000 a year, as much as 50 percent of their benefits may be taxable. For those earning more than $34,000, up to 85 percent are taxed. Couples earning less than $32,000 are exempt; between $32,000 and $44,000, they may be required to pay 50 percent; and if their income is more than $44,000, they could have to pay up to 85 percent on their benefits.
Besides federal taxes, some states also tax Social Security benefits. If you live in one of these states, you should check with your state tax agency to find out more.
To complicate things further, if you retire before full retirement age, you are only allowed to make a certain amount of money other than your Social Security benefits before your benefit amount will be affected. However, if when you reach the full retirement age, there is no such limit.
If you do have to pay taxes on your Social Security benefits, you can make estimated payments each quarter, or you can have taxes withheld from your monthly check.
How to minimize the taxes you owe
There are some strategies that you can use to minimize the amount of taxes you will owe. First, where you retire makes a difference. As stated above, 13 states tax these benefits in addition to the federal tax. Of course, that will take a bigger bite out of your benefits.
Second, plan ahead. You may want to consider a Roth IRA. This lets your money grow without taxation, and there is no age limit on when you can contribute or required distribution amount, so you can leave the money there until you will benefit from it the most. You can withdraw from your Roth IRA, and it will not change the tax calculation. You can also withdraw money from your savings account and will not have to pay taxes on that amount, either.
It is also a good idea to minimize expenses before retirement. If you can pay off your mortgage, that is probably your biggest expense, and it will be easier to live on a smaller amount on which you will pay less tax.
When you file your tax return, be sure to take advantage of all the deductions possible. This can certainly help. Medical and dental expenses are a big expense for retired people. If you itemize, you can deduct these expenses if they equal 10 percent of your adjusted gross income. Many retired people want to downsize and move to a smaller home. If you have lived in your home for two of the five years prior to selling, the profit on your home is not taxable unless it exceeds $250,000 for single taxpayers or $500,000 for married taxpayers.
To reduce your tax liability, you may still contribute to a retirement plan, even if you are retired or semi-retired. If you own a business, either part-time or full-time, you can deduct all necessary expenses of running the business. Just as when you were working, you may still deduct charitable contributions.
If you are unable to itemize, you are entitled to a higher standard deduction if you – or both you and your spouse, for couples – are 65 or older. The best way to earn money when you are retired is with investments, and many of the costs involved with investing are tax deductible.
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