This Social Security Surprise Could Upend Your Retirement Budget

For many Americans, claiming Social Security is a long-awaited milestone -- the moment when decades of hard work and loads of taxes finally translate into a steady retirement paycheck. But before you start counting your monthly benefits, there's something important you should know.

Social Security benefits are not exempt from taxes. You'd think they would be, since the whole reason you're eligible for them is that you paid taxes on your wages throughout your career.

Image source: Getty Images.

In spite of that, you'll need to add Social Security to the list of taxable income sources in retirement. But there may be a way to get out of paying those taxes you should know about.

Who pays taxes on Social Security benefits?

You may be counting on your complete Social Security checks to get you through retirement. So it's important to know if you should plan on losing a portion of that income to taxes.

Whether that's the case depends on your provisional or combined income. That's calculated as the total of half of your Social Security income for the year, your adjusted gross income (AGI), and any tax-free interest income you receive (such as interest from a municipal bond investment).

If your provisional or combined income exceeds $25,000 as a single tax filer or $32,000 as a joint tax filer, you risk taxes on your Social Security benefits. It's that simple.

That said, the One Big Beautiful Bill Act (OBBBA) introduced a new $6,000 senior tax deduction that may change that formula. Thanks to the new deduction, an estimated 88% of seniors are expected to pay no taxes on their Social Security benefits, the White House says.

However, the new $6,000 tax deduction phases out for higher earners. So if you fall into that category, you may end up having to pay taxes on those benefits after all. One strategic move on your part, however, could get you off the hook even if you have a lot of money.

A Roth conversion could be key

You may have heard during your working years that you'd need savings to supplement your Social Security benefits. And you may have consistently funded an IRA or 401(k) plan to ensure that money wouldn't be a problem in retirement.

If you contributed to a traditional retirement plan, though, you're looking at taxable withdrawals once you start tapping your IRA or 401(k). Those withdrawals will be counted in your AGI. And if they're substantial, they could easily push your provisional or combined income to the point where taxes on Social Security are hard to avoid, even with the new senior tax deduction.

A Roth conversion could change all of that, though.

With a Roth conversion, you move money out of a traditional retirement plan and into a Roth. When you tap your Roth account, you won't be taxed on your withdrawals, and they won't be included in your AGI.

The result? You may be able to withdraw many thousands of dollars each year in retirement from your savings without risking taxes on your Social Security benefits.

However, if you're going to do a Roth conversion, proceed with caution. The money you move into a Roth account will count as taxable income that year. If you're on Medicare or gearing up to enroll, converting too much money at once could lead to surcharges on your Part B premiums.

All told, it's not a given that you'll end up having to pay taxes on your Social Security benefits. Between the new $6,000 senior tax deduction and the option to do a Roth conversion, you may be able to shake that burden.

But it's important to know that taxes on Social Security benefits do exist and that the OBBBA did not get rid of them. Understanding how those taxes work could help you avoid a truly unpleasant financial surprise.

The Motley Fool has a disclosure policy.