3 pitfalls that retirees must avoid in 2024

By | December 23, 2023

Getty Images Social Security Calculator Card Statement

Getty Images Social Security Calculator Card Statement

Social Security is an essential part of almost every American’s retirement plans. Nearly nine in 10 retirees say Social Security is a major or minor source of income in retirement, according to an annual Gallup poll. So keeping as many monthly checks as possible can play a crucial role in your ability to enjoy your retirement.

Social Security taxes can be extremely complicated, and there are some major pitfalls you can fall into if you’re not careful. It’s important to understand the basics of how Social Security taxes work. Then you’ll understand how different retirement strategies can deliver big surprises at tax time.

A social security card under a calculator and on top of a financial statement.A social security card under a calculator and on top of a financial statement.

Image source: Getty Images.

How the federal government taxes Social Security

The federal government uses a measure called “combined income” to determine what portion of your Social Security benefits, if any, are taxable at the federal level. Combined income is equal to the sum of your adjusted gross income, non-taxable interest income, and 50% of your Social Security income.

If your combined income exceeds the thresholds in the table below, some of your Social Security benefits will become taxable.

Taxable part of the benefits

Some files

Joint filers

0%

Less than $25,000

Less than $32,000

Up to 50%

$25,000 to $34,000

$32,000 to $44,000

Up to 85%

Over $34,000

Over $44,000

Data source: Social Security Administration.

As you can see, those thresholds are relatively low. That’s because they haven’t been updated for inflation in at least 30 years. It is therefore necessary to keep your joint income as low as possible to avoid social security taxes.

Although you can’t control your Social Security income once you start collecting it, many retirees have some flexibility in their total adjusted gross income. Much of that income will consist of withdrawals from retirement accounts and capital gains from investments in retirement. And these two areas can pose major pitfalls for your taxes in retirement, along with one other factor.

Pitfall no. 1: Capital gains

U.S. tax law gives a lot of preferential treatment to long-term investors. In fact, many retirees can often sell their long-term stock and bond holdings without any tax liability, thanks to a generous 0% capital gains tax bracket.

The bottom line is that if you keep your taxable income (including capital gains) below $47,025 for single filers or $94,050 for joint filers, you won’t pay taxes on long-term gains in 2024.

However, just because you don’t pay taxes on these capital gains doesn’t mean they don’t contribute to your adjusted gross income. And by extension, they add to your combined income, which can make more of your Social Security income taxable. Although you won’t pay taxes immediately on taking more capital gains than you need in retirement, you could end up paying more on your overall tax bill because of Social Security taxes.

A tax form under a calculator and pencil.A tax form under a calculator and pencil.

Image source: Getty Images.

Pitfall #2: 401(k) and IRA withdrawals and conversions

Another common source of retirement income is withdrawing money from retirement accounts such as a 401(k) or IRA. The IRS taxes these withdrawals just like regular income, and they count toward your adjusted gross income.

It is possible to avoid paying taxes on withdrawals from your retirement account by taking only the standard deduction. For married couples with one spouse age 65 or older filing jointly, the standard deduction in 2024 is $30,750.

Even if you only take up to the standard deduction, you’ll be putting a significant portion of your Social Security income into your taxable income under federal rules. That’s because Social Security income becomes taxable when your combined income exceeds $32,000, according to the table above.

Many retirees are considering Roth conversions to maintain current tax rates. The tax code is scheduled to return to pre-2018 tax rates starting in 2026, so setting an income tax rate of 10% or 12% while they are available is attractive to many.

To lock in those rates, a retiree can simply convert money from a traditional IRA to a Roth IRA and pay the taxes this year. However, there may be additional costs if that conversion results in more Social Security income becoming taxable.

Pitfall No. 3: Ignoring state taxes

Even if you manage your finances carefully to avoid significant taxes at the federal level, you may end up paying for them at the state level.

There are 10 states that will tax certain Social Security benefits in 2024:

  • Colorado

  • Connecticut

  • Kansas

  • Minnesota

  • Montana

  • New Mexico

  • Rhode Island

  • Utah

  • Vermont

  • West Virginia

Each state has different tax laws when it comes to how they tax Social Security. Many have higher exemption limits than federal tax laws. If you’re unsure how your state determines what percentage of your Social Security, if any, is considered taxable income, it may be helpful to consult an accountant or financial planner to understand how different financial moves will affect your tax bill .

While taxes shouldn’t be the determining factor in deciding where to retire, you should consider state taxes. Because relatively few states tax Social Security, it often slips through the cracks of mainstream retirement planning advice. But for those who are affected, state taxes can play an important role in your retirement budget.

Simply keeping these common tax pitfalls in mind can help you make the most of your Social Security benefits in retirement.

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Paying Taxes on Social Security Benefits: 3 Pitfalls Retirees Should Avoid in 2024 was originally published by The Motley Fool

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