Many retirees rely on Social Security benefits as a vital source of income, but for an increasing number, those benefits are being reduced due to what is known as the “stealth tax.” While this term may sound ominous, it simply refers to how higher-income retirees lose a portion of their Social Security benefits to taxes. As a result, many find themselves with less money than they anticipated, despite receiving the same nominal Social Security check each month. Here’s how the stealth tax works and why it’s affecting more retirees every year.

What Is the Stealth Tax?

The term “stealth tax” refers to the taxation of Social Security benefits for individuals whose combined income exceeds a certain threshold. The tax is not a direct deduction from Social Security benefits but rather an increase in the taxable portion of those benefits. The more you earn, the higher the percentage of your Social Security benefits that will be taxed.

How Social Security Benefits Are Taxed

Social Security benefits are subject to federal income tax based on your combined income, which includes:

• Your adjusted gross income (AGI)
• Nontaxable interest
• Half of your Social Security benefits

For single retirees, the threshold for taxing Social Security benefits is $25,000 in combined income, and for married couples, it’s $32,000. Once you surpass these income levels, a portion of your Social Security benefits becomes taxable.

How the Tax Works

If your combined income exceeds these thresholds, up to 85% of your Social Security benefits can be subject to federal income tax. Here’s how it works:

• Single Filers: If your combined income is between $25,000 and $34,000, up to 50% of your Social Security benefits will be taxable. If your combined income exceeds $34,000, up to 85% of your benefits will be taxed.
• Married Couples: If your combined income is between $32,000 and $44,000, up to 50% of your Social Security benefits will be taxable. For incomes exceeding $44,000, up to 85% of your benefits are taxable.

The key issue with the stealth tax is that many retirees are unaware that their Social Security benefits could be subject to taxation once their income exceeds the thresholds. Additionally, the thresholds haven’t been adjusted for inflation in a way that keeps pace with rising income levels. As a result, more and more retirees are finding themselves subject to this tax each year, even if they haven’t experienced any significant changes in their income.

Why the Stealth Tax Affects More Retirees Every Year

The stealth tax is impacting more retirees each year for a few reasons:

1. Inflation and Rising Income: The thresholds for taxing Social Security benefits are not indexed to inflation in a meaningful way. As wages and retirement savings grow over time, more people are pushed above the income thresholds, causing them to face this hidden tax.
2. Rising Tax Rates: In addition to inflation, the broader tax environment in the U.S. is becoming more complex. Tax rates and income thresholds for other sources of income may contribute to a higher combined income, inadvertently increasing the amount of Social Security benefits that are taxed.
3. Increased Retirement Savings: With the rise of 401(k)s, IRAs, and other retirement savings plans, many retirees are drawing more income from their savings than they did in previous generations. This additional income can push their total combined income over the tax threshold, making their Social Security benefits taxable.

Impact of the Stealth Tax on Retirees

The stealth tax can reduce the purchasing power of Social Security benefits, which are already limited for many retirees. When up to 85% of benefits are taxed, retirees can lose a significant portion of their income without realizing it. This can lead to budget shortfalls, especially for those who have planned on using Social Security as their primary source of retirement income.

For example, a retiree who receives $2,000 per month in Social Security benefits could end up losing a substantial portion of that amount to taxes. Depending on their combined income, they may only keep $1,500 or $1,700 of their benefits, which could make it more difficult to cover everyday expenses.

What Can Retirees Do to Minimize the Stealth Tax?

While you can’t control the federal tax system, there are strategies that retirees can use to minimize the impact of the stealth tax:

1. Delay Social Security Benefits: By delaying your Social Security benefits until age 70, you could reduce the amount of income you need to draw from other sources, potentially lowering your combined income and avoiding the stealth tax.
2. Strategically Withdraw from Retirement Accounts: Managing withdrawals from retirement accounts like IRAs or 401(k)s can help you keep your income below the threshold for Social Security taxation. Spreading out withdrawals can prevent your combined income from rising too quickly.
3. Consider Roth Conversions: Converting traditional IRA funds into Roth IRAs could help you lower your taxable income in retirement. While Roth conversions are taxed upfront, they can reduce the taxable portion of your benefits later.
4. Consult a Tax Professional: A tax professional can help retirees navigate the complexities of Social Security taxation and develop a strategy to minimize taxes on benefits.

Conclusion

The stealth tax is a growing issue for retirees, and it’s affecting more people each year as inflation and rising incomes push them above the income thresholds. Understanding how this tax works and implementing strategies to reduce its impact can help retirees keep more of their Social Security benefits and maintain their financial security in retirement. By planning carefully and seeking professional advice, retirees can avoid surprises and ensure they make the most of their Social Security income.

For more information on Social Security taxes and strategies to minimize them, visit the Social Security Administration website.

Note: Every piece of content is rigorously reviewed by our team of experienced writers and editors to ensure its accuracy. Our writers use credible sources and adhere to strict fact-checking protocols to verify all claims and data before publication. If an error is identified, we promptly correct it and strive for transparency in all updates.