Will My Retirement Fund Withdrawals Affect My Social Security Benefits?

Social Security provides a guaranteed source of income in retirement, but what many don’t realize is that you’re not guaranteed to keep it all. Some retirees owe taxes on their Social Security benefits, but it all depends on your income. Here’s a closer look at how your retirement fund withdrawals play into all of this.

It’s all about combined income

Your combined income determines whether you owe taxes on your Social Security benefits. This is defined as your adjusted gross income (AGI) plus nontaxable interest plus half of your annual Social Security benefits.

Your AGI is your income for the year minus certain tax deductions, like self-employment taxes and contributions to tax-deferred retirement accounts. Money you withdraw from tax-deferred retirement accounts, like most 401(k)s and traditional IRAs, does count toward your AGI, but Roth retirement account withdrawals do not. You already paid taxes on your initial contributions to these accounts and the money grows tax-free afterward. You shouldn’t have to worry about nontaxable interest in your combined income calculation unless you have tax-exempt bond funds in your portfolio.

So a single individual with an AGI of $20,000 with $1,000 in non-taxable interest and a $12,000 annual Social Security benefit would have a combined income of $27,000 ($20,000 + $1,000 + $6,000 = $27,000). 

Single adults with a combined income exceeding $25,000 and married couples filing jointly with a combined income exceeding $32,000 could pay taxes on up to 50% of their Social Security benefits. Single adults with a combined income greater than $34,000 and married couples filing jointly with a combined income greater than $44,000 could owe taxes on up to 85% of their benefits.

But just because you could owe taxes on 50% or 85% of your benefits doesn’t mean you’ll actually pay this much. The Social Security benefit tax formula is beyond the scope of this article, but here’s a more detailed guide explaining how it works. You can use these formulas to calculate how much you’ll actually owe.

How to avoid Social Security benefit taxes

Most retirees’ only sources of income are Social Security and withdrawals from their retirement accounts. Being smart with your retirement account withdrawals can reduce your odds of owing taxes on your Social Security benefits. If you know you’re approaching one of the taxation thresholds mentioned above, try to avoid withdrawing more money from your tax-deferred retirement accounts for the rest of the year. You can live off of Roth retirement savings if you have any, because these don’t affect your tax bill at all. Or you can just cut back your spending temporarily. Think carefully before doing this, though. Avoiding Social Security benefit tax may not be worth penny-pinching for several months. You might just be better off paying the taxes and spending your money as you choose.

Delaying Social Security benefits could also help reduce your risk of owing taxes on your benefits. The soonest you can sign up for Social Security is 62, but you must wait to claim benefits until your full retirement age (FRA) if you want your full scheduled benefit based on your work record. Starting early will cost you. You’ll only get 70% of your scheduled benefit per check if you begin benefits at 62 and have an FRA of 67 or 75% if your FRA is 66. You can also delay benefits past your FRA and your checks will keep increasing until you reach the maximum benefit at 70. This is 124% of your scheduled benefit per check if your FRA is 67 or 132% if your FRA is 66.

You can’t owe taxes on Social Security benefits if you’re not receiving any. Delaying benefits until your FRA or beyond will increase the size of your checks so that they’ll go further in retirement. This helps reduce how much you must withdraw from your retirement savings each month, which will in turn lower your AGI. Only half of your Social Security benefits count toward your combined income calculation, so while larger checks will increase your combined income somewhat, your lower AGI will partially or completely counteract this.

You might not be able to get around Social Security benefit taxes and still make ends meet. But it still pays to understand how all of this works so that you don’t run into any surprises come tax time. If you’re not retired or claiming Social Security benefits yet, start planning out when you’re going to start Social Security and consider stashing some money in Roth accounts to reduce your risk of Social Security benefit taxes when you are ready to retire.

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