Taxes on Social Security in Michigan

If you earned $50,000 per year in a 35 year career, you would have paid around $110,000 in social security taxes. Also, let’s not forget that your employer would have paid the same amount of taxes on your behalf, which means that there would have been nearly $220,000 paid in social security taxes throughout your career.  Well, the good news is that at least when you are done working, you are done paying social security taxes.  The bad news of course, is that you aren’t done paying taxes.  In fact, there is a really good chance that you will be paying taxes on your social security benefit.  This post explains the taxes that you will pay on your social security benefit both here in Michigan and to the federal government.    

Michigan State Taxes

Woohoo! Many people don’t realize that you don’t have to pay Michigan state taxes on your social security benefit.  There are 13 states that currently tax your social security benefit and thankfully, Michigan isn’t one of those.  Thinking about moving to Florida to avoid paying state taxes?  Truth is, if a majority of your income in retirement is from social security, you may actually be paying a minimal amount of Michigan state income taxes. This article explains how you are still paying Michigan state taxes on pension and other types of pre-tax retirement income as long as you were born after 1952.  

Here is a quick chart that shows the amount of Michigan state income taxes you will pay given different income levels.  Of course, this is only income that is subject to Michigan state income taxes and assumes that you were born after 1952.  

Single

Social Security Other Income Total Income Total MI Taxes Effective MI State Tax Rate
$20,000 $25,000 $45,000 $893 1.99%
$20,000 $50,000 $70,000 $1,955 2.79%
$20,000 $100,000 $120,000 $4,080 3.40%
$20,000 $150,000 $170,000 $6,205 3.65%
$20,000 $250,000 $270,000 $10,455 3.87%
$20,000 $500,000 $520,000 $21,080 4.05%

Married

Social Security Other Income Total Income Total MI Taxes Effective MI State Tax Rate
$36,000 $25,000 $61,000 $723 1.18%
$36,000 $50,000 $86,000 $1,785 2.07%
$36,000 $100,000 $136,000 $3,910 2.88%
$36,000 $150,000 $186,000 $6,035 3.24%
$36,000 $250,000 $286,000 $10,285 3.60%
$36,000 $500,000 $536,000 $20,910 3.90%

As a reminder, Michigan state tax rate is 4.25%.  As a single individual, you are exempt from the first $4,000 of income for Michigan state taxes and if married, you are exempt from the first $8,000.  I have used average social security benefits, and yours could vary significantly.  “Other Income” is pre-tax retirement withdrawals or your pension benefit.  The “Effective MI State Tax Rate” is total income (social security plus other income) divided by total taxes paid.  

It is pretty obvious from the chart but although the Michigan state tax rate is 4.25%, you will be paying quite a bit less than that if a significant amount of your income is from social security.  

Federal Taxes

If you think calculating your Michigan state income taxes is difficult, you haven’t seen anything yet.  Dust off the old calculator (or just use the one on your phone) because we need to do some math.  The good news about social security is that at least 15% of your benefit will be completely tax free, and if your combined income is low enough, your whole benefit is 100% tax free.  

First, we need to figure out your “combined” income.  Never heard of combined income before?  That’s ok, basically no one has.  From the Social Security Administration:   

Your adjusted gross income (AGI)

+ Nontaxable interest

+ ½ of your social security benefit

= Your Combined Income

For reference, your AGI is the bottom number on the front page of your tax form 1040.  It is essentially all of the income that you earn, minus deductions such as IRA and HSA contributions.  Nontaxable interest is interest that you earn from municipal bonds, which is not subject to federal income taxes.    

Now that you know your combined income, you can determine the amount of your social security benefit that is taxable.  Again, from the Social Security Administration:    

If you:

  • file a federal tax return as an “individual” and your combined income is
    • between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your benefits.
    • more than $34,000, up to 85 percent of your benefits may be taxable.
  • file a joint return, and you and your spouse have a combined income that is
    • between $32,000 and $44,000, you may have to pay income tax on up to 50 percent of your benefits
    • more than $44,000, up to 85 percent of your benefits may be taxable.

In other words, if you are single you will pay no federal taxes on social security if your combined income is less than $25,000.  If combined income is over $34,000, pretty good chance that 85% of your social security benefit will be added to taxable income and subject to federal taxes.  If your combined income is between $25,000 and $34,000, between 50% and 85% of your benefit is subject to taxation.  

If you are married and your combined income is less than $32,000, your social security benefit will be tax free.  If over $44,000, 85% of your benefit will be added to income and subject to federal state taxes.  If combined income is between $32,000 and $44,000, between 50% and 85% of your benefit is subject to taxation.  

It is apparent from the “combined income” equation that the higher your AGI, the more taxes that you pay on your social security benefit.  Therefore, let’s discuss some options for lowering your AGI in retirement:  

  1. Make HSA Contributions:  If you have access to a high-deductible healthcare plan, you can continue to make HSA contributions, even in retirement, until you turn on Medicare (typically age 65).  This reduces your income by the amount of HSA contribution that you make.  You only want to make HSA contributions with after-tax money, if you need to take an IRA distribution in order to make an HSA contribution, this defeats the purpose and won’t have any impact on your AGI.
  2. Make IRA contributions:  You can make IRA contributions as long as you have earned income or if your spouse has earned income.  If your spouse is still working, and you are collecting your social security benefit, consider making a spousal IRA contribution to lower your AGI.  You can make these types of contributions until you turn age 70 ½ as long as you or your spouse has earned income.  
  3. Make a Qualified Charitable Distribution (QCD):  When you are forced to take Required Minimum Distributions you can direct your distribution to a charity.  The QCD can satisfy your Required Minimum Distribution without being forced to pay taxes on a distribution that you may not need.  

One of the nice things about living in Michigan is that your social security won’t be taxed in retirement.  Unfortunately, there is a real good chance that you will be paying at least some federal taxes on your social security benefit.  A good rule of thumb is that, if you are married and have total income (social security, pension, and retirement withdrawals) over $55,000, there is a good chance that 85% of your social security will be subject to taxation.  If you are single and earn over $44,000, there is a good chance that 85% of your benefit will be taxable.  If you are on the border, there are some things that you can do to potentially lower your AGI and save some taxes on social security.  

One last tip, don’t kill yourself to save a few bucks on social security taxes.  Don’t forego that retirement withdrawal just because it will put you over the limit in which more of your social security will be taxed.  We would all prefer to pay less in taxes, but I would never say no to a raise at work because I have to pay taxes on the extra income.  There may be some things that you can do to reduce the amount of taxes you pay in retirement, but it shouldn’t be at the expense of having an enjoyable retirement.  

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