Social Security is a major milestone for many, and there is a lot of information and strategy regarding how and when to take it and how it is taxed. In this article, we will discuss the following: 

• How your Social Security is taxed
• How states tax your Social Security benefit
• When you should begin taking Social Security
• The rules for claiming your benefits
• How a financial advisor can help

Social Security is just one of many aspects of retirement planning. Is your retirement plan structured appropriately? Learn more here.

How are my Benefits Taxed?

For roughly 40 years, Social Security income has been subject to tax above set income limits. Most individuals have other forms of retirement income to also strategize their taxes for. However, no taxpayer will have all of their Social Security benefits taxed, as the most possible is 85% of the total payment.

When the IRS calculates the tax rate, they start with your adjusted gross income, or AGI. They then add any tax-exempt interest to their calculation. If the final amount exceeds the minimum levels for taxation, then you will be taxed at a rate of at least 50% of your Social Security benefits. 

The amount you owe will depend on where the final number lands in relation to the federal income tax rate. However, most Americans will end up being taxed either 50% or 85% of their Social Security payments. 

How do States Tax Social Security Benefits?

There are 38 states and the District of Columbia which do not levy any sort of tax on Social Security benefits for their residents. The full list of states that have some state taxes on your benefits is: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, and West Virginia. 

These states all have different policies on taxing Social Security income. Some states follow federal guidelines, while others provide their own deductions and exemptions based on age and income. One of the states listed, Colorado, is ending its taxation of Social Security at the end of 2022, and Social Security benefits will be tax-free. 

When Should you Begin Taking Social Security?

You are eligible to begin taking Social Security benefits at age 62. However, it will not be the full amount of your benefits. You will be entitled to receive your full benefit once you reach your full retirement age, and you can increase this amount even more should you elect to delay taking them until age 70. 

If you decide to receive your benefits early, they will be reduced by a small percentage each month before you hit your full retirement age. The Social Security Administration has a Quick Calculator on their website that can help you see what your income will look like at the different ages you could potentially draw. 

While those are the options available to you, when you actually decide to draw is a different story. There are many different schools of thought when it comes to withdrawing Social Security. 

Many advisors recommend delaying your benefit, believing the payoff of additional money in the long run is the prime benefit. While that is true, the issue with this is many Americans depend on their Social Security payment as combined income with their other retirement accounts to keep them afloat after they retire. 

Another school of thought is to take your benefit immediately. Sure, you will get less money, but this could be a great option based on your life expectancy and overall financial standing. 

Though many advisors recommend delaying your benefits, they are only thinking of one facet of your financial portfolio: Social Security. While you will get more money from your Social Security payments, how does it impact the rest of your portfolio?

For example, let's say you need $4,000 per month to live comfortably in retirement. You have a rental property that brings you in $1,800 net per month, leaving $2,200 left for you to figure out per month. If you take your Social Security payment at age 62, the payment will be $1,700 per month. 

However, if you delay until your full retirement age, it will be $2,700 per month. If you decide to take your benefit at age 62, you will only need to withdraw $500 per month from your IRA or 401(k), or $6,000 per year. This is extremely manageable. However, suppose you choose to delay your benefit. In that case, you will need to withdraw $2,200 per month to live comfortably, which will very likely decimate your retirement account and possibly bump you into the next tax bracket. 

Furthermore, while you will make more money per month by delaying your benefit, the payoff will not be immediate. Using the previous example, let's compare the money if you took it at age 62 at $1,700 per month and if you delayed to your full retirement age of 67, where it would be $2,700 per month. In the five years between the two scenarios, you would have withdrawn $102,000 in total payments. 

In order to break even, it would take 8.5 years if you decided to postpone your benefit; you would be nearly 76 years old before you broke even compared to if you had taken money at age 62.

Life expectancy is going to play a significant factor in financial planning in retirement. Everyone's personal situation, life expectancy, and finances will be different. As financial advisors in Columbia, SC and Greenville, SC, we are here to serve our clients in the Carolinas for all of their retirement and financial planning needs, including Social security strategy. Don't hesitate to reach out today. 

The Rules for Claiming Social Security

To be eligible for Social Security benefits, you must be at least 62 or older and have sufficient work credits. 

Work credits are how the Social Security Administration measures work. You are eligible to earn up to four credits yearly based off of your annual earnings. As wages fluctuate and rise, the required earnings per year to receive a work credit increases.

A bare minimum of six work credits is required regardless of your age, and the maximum you can receive in a lifetime is 40 credits. To be eligible, you are required to have earned an average of one work credit per year between ages 21 and 62. 

How can a Financial Planner Help?

Social Security is a substantial part of most people’s retirement plan, and also a major source of income for many Americans once they retire. Many people choose their target retirement age based on when they can begin to withdraw money from Social Security.

There are many strategies when it comes to Social Security, although at the end of the day, it is just one (significant) facet of your larger financial plan. In retirement, you will have many sources of income, including Social Security. However, tying them together and structuring them smoothly and efficiently can be difficult. Working with a financial planner can help make the process easier and more streamlined. 

As financial advisors with offices in Columbia, SC and Greenville, SC, we specialize in financial and retirement planning. Choosing the optimal strategy for withdrawing Social Security is something we have a wealth of experience in, as well as investment management and tax -planning for both pre-retirees and retirees in the Carolinas. 

With our team of financial professionals on your side, no task in retirement is too difficult to handle. Talk with us today to see how we can help.