Although there can be many reasons why your taxes this year could be higher than you expect, such as having to report a capital gain or taking a lump-sum retirement plan distribution, one of the major culprits of this problem can be the income you draw from social security. When social security began back in the thirties, it was originally slated as tax-free income. However, over the years Congress has enacted legislation that has eroded this tax-free status. The general parameters for the current taxation of social security are broken down as follows:
Income levels requiring taxation of social security income
|Single||$25,000 – $34,000|
|Married Filing Jointly||$32,000 – $44,000|
Once your income respective to your filing status reaches these levels, then 50 to 85 percent of your social security income can become taxable. This can quickly have a substantial impact upon your tax return, as many Americans receive up to $20,000 of social security benefits per year. Furthermore, very few recipients have any tax withheld from this income, as most believe that they will not be taxed on it. But even a modest pension income can make a large amount of your social security benefits taxable. For example, if you are single and you draw $15,000 a year from a company pension, and you also receive $16,500 in social security benefits, then that will effectively subject close to 85% of your benefits to taxation. Mathematically, that comes out to around $14,000, resulting in a possible tax bill somewhere between $1,400 – $2,000. And, of course, if you have additional investment income of any kind from bonds, CDs or mutual funds, then that will increase your taxes as well.
The good news is that, for many Americans, there are ways to either eliminate or greatly reduce their tax bills. One of the key methods to achieving this is by moving taxable fixed-income assets into tax-deferred fixed annuities. This effectively allows the taxpayer to only pay tax on the actual taxable portion of each distribution, and not on the interest that is still compounding within the annuity. With taxable CDs or other fixed income investments, all interest is taxable, whether it is paid out or not. This income can therefore also increase the taxation on your social security benefits.