You may be overlooking this reason to delay Social Security benefits

  • When deciding when to claim Social Security, it is important to consider how your benefits and other income will be taxed.
  • Up to 85 percent of your benefits could be subject to income taxes, depending on your personal situation.
  • You will need to plan for the taxes you owe in retirement, whether you have money withheld from your Social Security checks or make payments to the IRS quarterly.

Just as taxes is a certainty in life, it also may be an inevitability when it comes to another important aspect of retirement: your Social Security benefits.

The fact that Uncle Sam could dip into your benefits could be yet another reason why you might want to delay claiming well past age 62.

Age 62 is the first point at which people are able to take their benefits. But because they are taking those payments early, those checks will be permanently reduced.

Age 66 or 67 is generally considered full retirement age, depending on the year in which you were born. At that point, you are eligible to receive 100 percent of your benefit.

If you delay beyond that, up until age 70, your benefit will grow by up to about 8 percent per year for every year you delay.

When deciding when to claim benefits, you should weigh your health, financial situation and marital status.

You also need to consider how your income from Social Security and other sources will be taxed.

"If you're concerned about taxation and you want to reduce the taxable income, the easiest solution there, at least temporarily, would be to delay your retirement benefits," said Stein Olavsrud, executive vice president at FBB Capital Partners.

In order to factor in how taxes affect your claiming decision, you need to understand the specific tax rules related to Social Security.

Not all of your benefits are taxable

The good news for retirees is that not all of your benefits will be subject to federal income taxes.

Up to 85 percent of your Social Security benefits could be taxable.

"It's very common for people to believe they're not taxed on their Social Security," Olavsrud said. "A lot of people are surprised when they realize they are taxed on that income."

Those taxes usually kick in when you have other income — such as wages, interest or dividends — in addition to your benefits.

Combined income Tax
Individual return  
$25,000 to $34,000 Up to 50% of your benefits
More than $34,000 Up to 85% of your benefits
Married filing jointly  
$32,00 to $44,000 Up to 50% of your benefits
More than $44,000 Up to 85% of your benefits
Source: Social Security Administration

If you file an individual return and your combined income — adjusted gross income, nontaxable interest and half of your Social Security benefits — is between $25,000 and $34,000, you may pay income tax on up to 50 percent of your benefits, according to the Social Security Administration.

If your individual income is more than $34,000, you may pay tax on up to 85 percent of your benefits.

If you file a joint return with your spouse, and your combined income is between $32,000 and $44,000, you may have to pay tax on up to 50 percent of your benefits.

If you and your spouse have more than $44,000 in income, you may be taxed on up to 85 percent of those benefits.

More people are paying taxes on their benefits

The way in which Social Security benefits are taxed was determined by changes Congress made to Social Security in 1983.

At that time, the first income threshold was created, whereby up to 50 percent of benefits were subject to federal income taxes.

A separate threshold for up to 85 percent of benefits was established in 1993.

Since then, the income thresholds for how benefits are taxed have stayed the same.

"When you're in retirement, you're now responsible for making sure your tax liability is taken care of throughout the year. … Understanding how Social Security plays into that can help you feel confident that you're making the right decisions." -Stuart Ritter, senior financial planner, T. Rowe Price

Yet, inflation has increased by an average of 2.69 percent a year, based on the Consumer Price Index, according to Gail Buckner, retirement and financial planning strategist at Franklin Templeton.

So while your Social Security benefit is adjusted for inflation and your earned income often also goes up with inflation, the threshold at which you pay tax on Social Security hasn't changed.

"It's like this big secret stealth tax," Buckner said. "More and more people are getting sucked into it every year."

While it is possible to avoid taxes on Social Security benefits, it is very difficult to keep your income low enough to make that happen.

"Unless you're getting very very little income from other sources, everybody is pretty much paying tax on Social Security benefits," Buckner said.

Delaying can help

For people who have other income, the easiest way to control taxes on Social Security is to delay taking your benefits, according to John Piershale, wealth advisor at Piershale Financial Group.

"You save yourself on the tax on that and at the same time get 8 percent growth in your Social Security credits, at least until age 70," Piershale said.

Keep in mind that if you do have earned income and you claim your Social Security benefits at 62, you will be subject to tax on that income.

If you earn more than $17,040 in 2018 and you claim Social Security at age 62, $1 will be deducted from every $2 you earn above that threshold.

That phases out once you reach full retirement age, Olavsrud said.

And you will receive higher monthly benefits if you delay between age 62 and full retirement age because of work, Olavsrud said.

"A lot of people view it as a tax and a penalty," Olavsrud said. "But in reality, it's just a deferment and those funds are paid back to you later."

If you think you will owe taxes, you have two options. You can have the Social Security Administration withhold part of your benefits, or you can pay quarterly taxes.

Using a calculator from the IRS can help give you a sense of how much of your benefit is taxable, said Stuart Ritter, senior financial planner at T. Rowe Price.

"When you're in retirement, you're now responsible for making sure your tax liability is taken care of throughout the year," Ritter said. "Understanding how Social Security plays into that can help you feel confident that you're making the right decisions."

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