When planning for retirement, the realization that your Social Security benefits might be taxed can come as a shock. While not everyone pays taxes on their Social Security, those who do may find a substantial portion of their benefits subject to federal income taxes.
Fortunately, there are several strategies to help reduce or avoid taxes on Social Security benefits. Let’s explore when Social Security benefits are taxable, how you can minimize or avoid taxes, and what strategies might work best for your financial situation.
When Are Social Security Benefits Taxable?
Social Security benefits become taxable based on your combined income, which is calculated by adding:
- Your adjusted gross income (AGI),
- Nontaxable interest (like municipal bonds), and
- Half of your Social Security benefits.
The IRS sets thresholds for when benefits are taxed:
- For single filers, if your combined income is between $25,000 and $34,000, up to 50% of your benefits may be taxable. If your combined income exceeds $34,000, up to 85% of your benefits could be taxed.
- For married couples filing jointly, if your combined income is between $32,000 and $44,000, up to 50% of benefits may be taxable. If your combined income exceeds $44,000, up to 85% of your benefits may be taxable.
These thresholds have not been adjusted for inflation since the 1983 Social Security Act Amendments, meaning more people are paying taxes on Social Security now than ever before. About 40% of Social Security recipients are subject to these taxes, and this number is expected to rise.
Strategies to Minimize or Avoid Taxes on Social Security
While avoiding taxes completely may not be possible once your income exceeds the thresholds, there are several strategies to help reduce the tax burden on your Social Security benefits:
1. Delay Social Security Benefits
One of the simplest ways to reduce taxes is to delay claiming Social Security until age 70. By waiting, you allow your benefits to grow by 8% annually after full retirement age, which increases your overall benefit.
Additionally, if you don’t need the income right away, delaying can help keep your taxable income lower for a longer period.
2. Stop Working or Reduce Work Hours
Continuing to work while collecting Social Security can push your combined income above the taxable threshold. If possible, consider stopping work or significantly reducing your income from employment once you start receiving Social Security.
Even part-time work can lead to higher taxes on your benefits. If you enjoy working, consider switching to volunteer work, which won’t affect your income.
3. Withdraw from Roth Accounts
If you have a Roth IRA or Roth 401(k), withdrawals from these accounts are tax-free (if the conditions are met) and do not count toward your combined income.
Using Roth withdrawals in retirement instead of taking distributions from traditional retirement accounts can help you stay below the taxable threshold for Social Security.
If you have funds in a traditional IRA or 401(k), consider converting them to a Roth IRA before starting Social Security benefits.
While you’ll pay taxes on the converted amount, future withdrawals from the Roth account will be tax-free, allowing you to reduce your taxable income during retirement.
4. Use Qualified Charitable Distributions (QCDs)
Once you turn 73, you’re required to take required minimum distributions (RMDs) from traditional retirement accounts, which increase your taxable income. To reduce your combined income, consider making qualified charitable distributions (QCDs).
You can donate up to $100,000 per year directly from your IRA to a charity, and the distribution won’t count as taxable income.
5. Take Advantage of Tax-Loss Harvesting
If you have investments in taxable accounts, you can use tax-loss harvesting to offset capital gains by selling investments that have lost value.
This can reduce your taxable income by up to $3,000 per year, helping you lower your combined income and potentially reduce taxes on your Social Security benefits.
6. Manage Withdrawals from Taxable Accounts
If you need to supplement your income with retirement account withdrawals, be strategic about which accounts you withdraw from. By prioritizing Roth withdrawals or tax-free investments, you can avoid adding to your taxable income.
Avoid unnecessary withdrawals from traditional IRAs or 401(k)s that would increase your combined income.
7. Live a Frugal Lifestyle
Living frugally can help reduce the need for large withdrawals from taxable accounts, which can keep your combined income under the taxable threshold for Social Security.
By reducing your expenses, you may not need to tap into your retirement accounts as heavily, thus lowering your income and reducing the taxes on your benefits.
When Is Social Security Not Taxable?
To avoid taxes on Social Security altogether, your combined income must be below:
- $25,000 for single taxpayers.
- $32,000 for married couples filing jointly.
If your income stays below these limits, your Social Security benefits will remain untaxed. However, for married taxpayers filing separately, Social Security benefits are typically subject to taxes regardless of income levels.
Should You Prioritize Avoiding Taxes?
While minimizing taxes on your Social Security benefits is important, it shouldn’t be your only focus. As financial experts often say, “don’t let the tax tail wag the investment dog.”
Your primary goal should be to structure your retirement income in a way that supports your financial needs and goals. Sometimes, paying taxes on Social Security benefits may be a trade-off for achieving larger retirement goals.
If you think your Social Security benefits will be taxable, consider asking the Social Security Administration to withhold taxes from your payments to avoid an unexpected tax bill at the end of the year.
While it may be disappointing to learn that your Social Security benefits can be taxed, there are strategies you can implement to minimize this burden.
Delaying benefits, managing withdrawals strategically, and making charitable donations are just a few ways to reduce your taxable income and keep more of your Social Security.
With careful planning and consideration, you can reduce the amount you owe in taxes while maximizing your retirement income.
FAQs
What is the threshold for Social Security to be taxed?
Single filers pay taxes on Social Security if their combined income exceeds $25,000. For married couples filing jointly, the threshold is $32,000.
Are Roth withdrawals taxed for Social Security purposes?
No, Roth withdrawals are tax-free and do not count toward your combined income for Social Security taxation.
Can I avoid paying taxes on Social Security if I stop working?
Yes, stopping work can reduce your combined income and help you stay below the taxable threshold.
How can QCDs help reduce Social Security taxes?
Qualified charitable distributions (QCDs) allow you to donate RMDs from your IRA to charity, avoiding taxable income.
Does delaying Social Security benefits help avoid taxes?
Yes, delaying benefits until age 70 can reduce your taxable income and increase your future Social Security payments.
