Social Security will pay out around $1 trillion in benefits in 2020, sending money to around 65 million Americans.
Not every benefits recipient gets to keep all of their money, though. In fact, Social Security retirees will lose a collective $38.9 billion of it this year. Here's why.
It has to do with a change made in 1983
Social Security retirement benefits recipients will lose a small fortune in 2020 because they'll have to pay it out in taxes on their benefits.
The 2020 Social Security Trustee's report estimates the program will collect $38.9 billion in tax revenue in 2020. This money will serve as an important source of funding, but it comes directly out of the pockets of current retirees who lose out on billions in benefits.
Not every retiree pays the same tax rate either, so some retirees bear the burden of supporting the program far more than others. A report from the Senior Citizens League found around half of all Social Security retirees paid taxes on their benefits in 2019, which was the same number as the prior year.
These taxes weren't originally charged on retirement benefits but were introduced in 1983 by amendments intended to shore up the program's finances. And when taxation was first introduced, it was largely well-to-do Americans who had to bear the brunt of it. But the thresholds at which taxes are charged wasn't indexed to inflation, and now they aren't very high.
For single tax filers, taxes are due on up to 50% of annual benefits once your countable income hits $25,000. Married filers owe taxes with a combined countable income starting at just $32,000. And for singles with a countable income of $34,000 or married filers with $44,000, up to 85% of benefits are taxable.
You'll notice these thresholds apply only to "countable" income, though, which includes half your annual Social Security benefit plus other taxable income. So the threshold at which you begin losing out on your benefits is a little higher than it appears at first glance. Still, millions of seniors are being deprived of nearly $40 billion in hard-earned retirement benefits in 2020.
How can you avoid taxes on your Social Security benefits?
Being forced to pay federal taxes on Social Security benefits can be painful, especially because it is your retirement money that you earned by paying taxes into the system.
But the good news is, many current workers can take one simple step to reduce or avoid taxes. They can invest in a Roth IRA or Roth 401(k). If you do, money you withdraw from your retirement account as a senior isn't considered countable income for purposes of determining if your benefits are taxable. You can take out as much money from these accounts as you want without worrying about it making your benefits subject to tax.
Current retirees also have the option to convert their traditional 401(k) or IRA accounts to a Roth by doing a Roth IRA conversion, but this has major tax implications, so it may be best to talk with a financial professional before deciding if doing so is the right move.
The $16,728 Social Security bonus most retirees completely overlook
If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,728 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.
The Motley Fool has a disclosure policy.
The business news you need
With a weekly newsletter looking back at local history.