How do taxes work on retirement income for someone who is retired?
If my pension is $28,000 a year and Social Security is $25,000, and I'm filing married, do I just pay taxes on the pension and not on the Social Security?
The taxation of Social Security benefits depends upon a formula called Provisional Income.
Basically, add up all your income - wages, investment income, including tax-free bond income, rental income, etc. Add to that sum 1/2 of your annual social security benefit. If that result falls between $32K and $44K, then 50% of the social security benefit will be taxable. If that number exceeds $44K, then 85% of that benefit will be taxable. NOT that the benefit will be taxed at 85% - just that 85% of the benefit goes on your 1040 along with all your other taxable income.
From the numbers you gave, 50% of your $25K Social Security benefit, or $12,500, is taxable.
One misconception people have is their Social Security benefit is non-taxable. That’s not true at all, and retirees will quickly find out that after the first year.
If one relies on SS benefits exclusively, then he/she may not have to pay any tax on the benefits.
On the other hand, if one has SS benefits in addition to pension and investment income (dividends, capital gains, rental income, etc.), the chances are that person will pay some tax on the social security benefits, from 50% to 85%. The formula is simple enough: your AGI (adjust gross income, which is the last line number on the first page of 1040) + tax-exempt income (i.e. income from municipal bonds, surprise!) + ½ of your social security benefits.
Since the threshold is not subject to inflation, which means they’re low enough that many middle-class Americans will be hit with some taxes on their SS benefits. For MFJ, if your combined income is between $32,000 to 44,000, up to 50% of your Social Security income is subject to tax. Once above $44,000, you can expect to pay taxes on up to 85% of your Social Security benefits.
So, assuming you don’t have any other investment income, your income is limited to pension and SS. Add them together, and you have an annual income of $40,500 ($28k + ½ of $25k), which put you in that 50% tax category.
I urge you to talk to a CFP® and/or RICP® to see what strategies may be available to you so you don’t have to pay extra social security taxes in the future. Best!