Trap No. 1: Social Security may be taxable
If your earnings exceed a certain level, up to 85% of Social Security benefits may be taxable. Even income sources that are normally tax-exempt, such as income from municipal bonds, must be factored into the total income equation for the purpose of computing tax on Social Security benefits.
Eric Levenhagen, CPA and a certified tax coach with ProWise Tax & Accounting, says to find out whether any of your Social Security benefits are taxable, "Look at your total taxable income plus half of your Social Security benefit. Make sure you add back any tax-exempt interest income."
When your taxable income, tax-free income and half of your Social Security benefit exceed $25,000 ($32,000 for married couples filing jointly), that's when you're in the zone to pay taxes on Social Security income.
Another unexpected income source that could impact taxes on Social Security: proceeds from a Roth conversion.
If you're thinking about doing a Roth conversion, do so before receiving Social Security benefits, says Steve Weisman, an attorney and college professor at Bentley University. "A lot of people considering converting a traditional (individual retirement account) into a Roth IRA should be aware that if they do that, they will end up paying income tax on the conversion, which will also be included for determining whether Social Security benefits are taxable," he says.