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SOCIAL SECURITY retirement benefits are a critical source of income for many seniors. But as I’ve discovered from preparing tax returns, there’s a lot of confusion surrounding two key issues.
The first issue: the reduction in benefits that occurs when folks claim benefits before their full retirement age (FRA) of 66 or 67, but continue to work. This is the so-called earnings test. If folks are under their FRA for the full year, the Social Security Administration will reduce their benefits by $1 for every $2 earned above $22,320, which is the earnings limit for 2024.
Suppose you earned $42,320, or $20,000 above the earnings limit. Your Social Security benefit would be reduced by $10,000. The maximum Social Security benefit for 2024 is $58,476. To lose this entire sum, you’d have to earn twice this amount, or $116,952, plus the earnings limit of $22,320, for a total of $139,272 in 2024.
In the year you reach your FRA, the earnings limit is significantly higher—it’s set at $59,520 for 2024—plus the reduction in benefits is $1 for every $3 earned above this limit. What happens once you get to your FRA? There’s no reduction in benefits, regardless of how much you earn. On top of that, once you reach your FRA, Social Security recalculates your monthly check, so you get credit for the benefits you earlier lost.
The second confusing topic: the taxation of Social Security benefits. Whether your retirement benefits are partially taxable depends on your combined income. What’s that? It’s your adjusted gross income, plus any non-taxable interest and half of your Social Security benefits. For a single person, if your combined annual income is less than $25,000, none of your Social Security benefits is taxable. Between $25,000 and $34,000, up to 50% of benefits are taxable. If your combined income is more than $34,000, up to 85% of benefits are taxable.
I was reminded of all this recently when I prepared a tax return while volunteering with AARP’s Tax-Aide program. Robert’s tax return stuck in my head for a few reasons. First, we shared a birthday, although—at age 68—he’s two years older than me. Second, his return is likely the simplest I’ll do this season.
He had one document, a 1099-SSA that reported his Social Security benefits. His benefit in 2023 was $33,050. From this, $1,979 was subtracted for his Medicare Part B benefits and $3,900 for alimony from a 1999 divorce. His net benefit was $27,171.
When I asked if he had any other sources of income, he said things were tough. He’d been on Social Security disability benefits for a number of years. When he reached his full retirement age two years ago, Social Security switched him over from disability benefits to retirement benefits.
Robert’s return only took a few minutes to prepare, but he had some questions. He was considering getting a job to supplement his income, but he’d heard that if he made too much it would reduce his benefit. We explained that, since he was past his FRA, his Social Security benefit would not be reduced based on earned income.
We then discussed the taxation of his benefits should he choose to work. He was aware that earned income could cause some or all of his benefits to be taxable, but wasn’t sure how much he could earn without a significant tax hit. For 2024, Robert’s standard deduction will be $16,450, comprised of the typical $14,600 standard deduction, plus $1,950 since he’s over 65. The sum of his earned income and any taxable Social Security benefits would have to exceed this amount before he’d owe federal income taxes.
Since Robert’s only income in 2023 was his Social Security benefits, his combined income was one-half of this, or some $16,500. This means he could have earned $8,500 before he’d have hit the $25,000 limit at which Social Security benefits become potentially taxable. And even if he surpassed this limit, he wouldn’t necessarily owe income taxes, thanks to the added tax relief offered by the standard deduction.
Because of the complexity of many tax code provisions, and the way they interact with each other, often generating a sample tax return is the only way to see how a change in one variable, like earned income, impacts a taxpayer’s final tax bill. This can be especially true when a person’s state taxes are as complicated as New Jersey’s.
The tax software we use made it easy to run a series of “what if” scenarios to see how various levels of earned income would impact Robert’s taxes. The calculations were based on 2023’s tax law. One of the thoughts I had was that Robert might be eligible for the earned income tax credit (EITC).
At low incomes, a single filer with no qualifying children could be eligible for a credit of up to $600. Robert wouldn’t be eligible for this federal credit because he’s older than the age 65 cutoff. But New Jersey provides a credit that’s equal to 40% of the federal amount and there’s no maximum age, so Robert could have earned $8,500 without owing anything in federal or state income taxes, plus he’d have been eligible for a $240 state EITC.
True, Robert would have paid $667 in Social Security and Medicare payroll taxes on the $8,500 of earned income. Still, with the state EITC credit, he would’ve netted $8,063 out of the $8,500. None of his Social Security benefits would be taxable. The additional income would represent a 30% increase in his standard of living. In fact, Robert could have earned $10,000 and still received New Jersey’s EITC, while paying no federal or state income taxes.
The table below summarizes Robert’s tax situation, and how various levels of income would affect his tax return. It shows that, for low-income retirees, a modest amount of income can dramatically increase their standard of living without significantly boosting their tax bill.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on X @RConnor609 and check out his earlier articles.
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Rick this was a superb article. I learned a great deal from it. Incidentally, yesterday, when my wife didn’t receive her SS deposit, we found out at the SSA office that a funeral home submitted my wife’s SSN as that of a deceased person. So, SSA had her deceased and the IRS, which was not processing my tax return, got a letter to us yesterday saying they needed more information about my return and that one of us was deceased. I think it’s all been straightened out, but it was something the SSA counselor said happens all the time. Again, thanks for the great articles.
I’m unclear how his $16,450 standard deduction fits in. Can’t that just be added to determine when he social security would become taxable? Thanks.
Thanks for the article Rick.
I like using my post full time work earned income (unretirement) for IRA contributions since the law changed to allow IRA contributions for older taxpayers. You can now contribute at any age if you (or your spouse if filing jointly) have taxable (earned) compensation and your modified adjusted gross income is below certain amounts. For some modest income taxpayers making a traditional IRA contribution in the following year by April 15 for the prior tax may allow them to precisely target using all of their bracket and standard deduction with the extra earned income to be at the exact taxable income level they want.
The AARP free tax calculator can be a helpful planning tool for all the moving parts that is our current tax code.
If taxable income after the extra earned income is less than zero putting extra earned income that is unused in a Roth IRA is a great tax free location for saving and maybe investing.
Thank you for volunteering to help others with their taxes.
Thanks Bill. I try to talk to our clients about making post-Jan 1 IRA contributions when it will help. It’s a great strategy when available. The gentleman in the this article was clearly having some medical and financial challenges. It’s difficult, and frustrating, when you only see the tax side of their lives. I often feel there needs to be a comparable free financial planning program analogous to VITA
I know this may sound cliche, but I really get so much out of helping people with their taxes. I’m really glad I got involved, and I hope my faculties hang around for awhile so I can continue.
Rick, I am encouraged by your volunteer spirit, and especially by your willingness to apply your substantial math and spreadsheet skills to the tax knowledge that VITA provides you, to assist lower income seniors who obviously really need the help. Kudos on volunteering your time in this noble cause, and may jewels be added to your crown one day.
Rick, I am also a retired aerospace engineer (maybe we worked at the same company), and really enjoy your posts. This post is especially relevant because it might help us decide whether my wife should take SS next year when she turns 62. She plans to work until at least age 65 and maybe till age 67 or 68 (her FRA is 67). I am now 71 and didn’t take my SS until after age 70 (I retired at age 70 + 5 months). In the process 6 years ago of evaluating financial advisors, a very good one we were considering (we never signed up with one) told us that, given these facts, she should probably take her SS as early as possible. However, her income is high enough that she will not receive much, if any, SS until after her FRA even if she does start it at age 62. In your 4th paragragh you wrote, “once you reach your FRA, Social Security recalculates your monthly check, so you get credit for the benefits you earlier lost.” To help us decide whether she should take SS at age 62 or not, would you mind providing more detail about how “Social Security recalculates your monthly check, so you get credit for the benefits you earlier lost.” Or perhaps you have a reference that would help; I haven’t been able to find information about this. It would be nice to know how SS recalculates, and subsequently pays, the credit for earlier lost benefits. Maybe it is better for her to just wait until the earlier of when she retires, or her FRA, whichever comes first, to take her benefits.
Paul, thanks for reading and commenting. Finding the specific method they use is not easy. My understanding is they take the lost benefits and recalculate the persons FRA in an actuarially fair way. Basically they spread them over your expected lifetime. Here is a document SSA recommends that gives an example of how a benefit is updated due to work after claiming. It doesn’t really tell you “how” they do it.
https://www.ssa.gov/pubs/EN-05-10069.pdf
This link gives a nice graphical example of how a reduction wold work in practice. Note the bottom right which shows says: Over a typical life span, a RET-affected beneficiary recoups most or all of the benefits SSA withheld before FRA.
Note b at the bottom says the adjust the reduction factors and they account for additional earnings. I have to say that any detailed actuarial calculations I’ve reviewed always surpassed me. they have their own way of doing things that is not straight Time Value of Money calc.
Here’s my understanding of how the recalculation works: Suppose you claim at 62, reach full retirement age at 67 and in between effectively lose three years of benefits because of the Social Security earnings test. At your full retirement age of 67, your benefit would be recalculated as though you’d claimed benefits at age 65, thus giving you credit for the three years of lost benefits.
I like Mike Piper’s free social security calculator which frames the SS claiming decision output in terms of joint present value and gives you the ability to modify key underlying assumptions.
https://opensocialsecurity.com/about
His approximate 100 page book Social Security made Simple is a good read and the Kindle price of $4.99 is a great value.
Of course a great starting point is reading Jonathan’s comments about social security in the retirement section of this online guide.
You may also benefit from watching the YouTube video from the 2022 Boglehead’s conference where Mike Piper was the speaker on social security.
https://www.youtube.com/watch?v=atTp3sATI44&ab_channel=Bogleheads
Rick, I was always enjoy your tax stories as there is usually something for me to learn.
It’s nice that you help your customers see how they can improve their financial situation with a little planning and advice.
Thanks Olin.
Richard, I suspect that a lot of HD readers get slammed with paying tax on 85% of their SS no matter what they try. For those with with more modest retirement income, like myself, a little tax planning can absolutely help with this situation. For example, fixed annuities for conservative savers can delay tax on SS. Conversely, income from non-taxable interest such as muni-bonds can trigger tax on SS.
Dan, thanks for reading and commenting. I’m definitely a fan of advance tax planning
Nice article. I believe the maximum social security benefit of $58,476 could only be attained at age 70, and there would be no reduction in benefits for any earned income at that age.
Good point Robert. Thanks for reading and commenting.