Why should individuals be aware of the tax implications of their Social Security benefits?

Individuals should be aware of the tax implications of their Social Security benefits because some benefits may indeed be subject to federal income tax based on their total income levels. The taxation of Social Security benefits is determined by what is called the "combined income," which includes adjusted gross income, nontaxable interest, and half of the Social Security benefits. Depending on the total combined income, individuals may have to pay taxes on up to 85% of their Social Security benefits. Understanding this aspect is crucial for financial planning, as it can affect the net amount received and overall tax liability in retirement.

Other options suggest misconceptions, such as the idea that all benefits are tax-free or that benefits are only taxed based on when they are received, which does not reflect the actual tax structure surrounding Social Security payments. Additionally, the claim that income from Social Security is not reported to the IRS is incorrect, as the IRS requires individuals to report their benefits, which influences their overall tax situation.