Ouch: A Retiree's $40,000 Dividends Suddenly Makes 85% of Social Security Taxable

"The core issue is how different income sources stack together. Dividend income from holdings like SCHD or VYM can reach $20,000 to $30,000 annually, while bond interest adds another layer. These amounts don't just get taxed on their own-they also determine whether Social Security benefits become taxable, creating a compounding effect that catches many retirees off guard. Social Security taxation hinges on "combined income"-the sum of your adjusted gross income, nontaxable interest, and half of your Social Security benefits."

"Consider a retiree receiving $35,000 in Social Security who also takes $40,000 in dividends and interest. The tax code requires adding the investment income to half the Social Security benefits to calculate combined income, which determines taxation thresholds. In this scenario, combined income reaches $57,500, well past the point where most Social Security becomes taxable. The result adds roughly $30,000 to taxable income-money that would have been tax-free with lower portfolio withdrawals."

Substantial portfolio income such as dividends and bond interest can push retirees' combined income above thresholds that make Social Security benefits partially taxable. Combined income equals adjusted gross income plus nontaxable interest plus half of Social Security benefits. Crossing the $25,000 threshold for single filers can make up to 50% or 85% of benefits taxable, adding significant taxable income. Example: $35,000 in benefits plus $40,000 in investment income yields combined income of $57,500, increasing taxable income by roughly $30,000. Taxable benefits can also push retirees into higher tax brackets, creating compounding tax effects.

Read at 24/7 Wall St.