How to Minimize the Taxes on Your Social Security Benefits
Social Security can be one of the most flexible tools in your retirement toolkit. Some seniors will depend on it. Some will use it to achieve or even upgrade bucket list goals. Some might treat it as an additional investable asset. And others might make their survivor's benefits a central part of their estate planning.
But I think all seniors will agree that no one wants their Social Security benefits to trigger unwelcome surprises at tax time.
As you're weighing when to take Social Security and how to use your benefits, discuss these four topics with your financial advisor. You may have several options to lower your tax liability and maximize the value of your benefits to your comprehensive financial plan.
1. Understand how Social Security is taxed.
According to the Social Security Administration, approximately 40% of seniors pay federal income tax on their Social Security benefits.
The amount of your Social Security benefits that are subject to taxation depends on what the IRS calls your "provisional income," which is the sum of:
- Your adjusted gross income (AGI)
- 50% your Social Security benefits
- Your tax-exempt interest (i.e. from municipal bonds)
If you are a single filer and your provisional income is from $25,000 - $34,000, then 50% of your Social Security benefits are counted as taxable income. If your provisional income is above $34,000, then 85% of your benefits may be taxable.
For married couples filing a joint return, the 50% threshold is from $32,000-$44,000, and the 85% threshold is above $44,000.
So, how can we control the taxes on your Social Security benefits if you're earning above those thresholds or if your benefits will push you over the top?
2. Delay taking Social Security.
This is the simplest option for folks who aren't already taking Social Security.
A comprehensive financial plan will almost always offer better options for meeting your retirement goals than losing 50% or more of your Social Security benefits. Alternative strategies will also let your benefits keep growing until you really need them, until it is most advantageous for your tax picture, or until you maximize your benefits at your full retirement age.
Note that if you do take your Social Security benefits and, within 12 months, you decide to start earning income again or see another taxable event on the horizon, you can tell Social Security to stop sending your checks so they won't be taxed. But unless you repay the benefits you've received in full, you're locked into that benefit rate once you do start taking Social Security again.
3. Adjust your withdrawal strategy.
If you are already receiving Social Security, you may be able to isolate your benefits from taxation by reducing the income you're earning from other sources.
For example, withdrawals from a Roth IRA are not subject to taxation and therefore, not part of your provisional income calculation. While it's usually best to allow tax-exempt accounts to grow as much as possible for as long as possible, there could be situations where a senior claiming Social Security taps into a Roth IRA first to keep their taxable income low.
You might also consider taking smaller distributions from taxable accounts, such as brokerage accounts, with an eye toward controlling your provisional income.
Folks who have a large IRA or 401(k) might also consider taking smaller distributions from these accounts ahead of schedule or making conversions into a Roth IRA. That way, when you have to start taking required minimum distributions at age 72, your tax-deferred RMDs will be a smaller portion of your provisional income.
Finally, once you reach age 70 1/2, you can make qualified charitable contributions (QCDs) directly from your traditional IRA to a qualified charity. QCDs are a great option for seniors who have to take RMDs, don't need them to pay the bills, and are looking for tax-efficient ways to give back.
4. Move to Missouri or Kansas!
Over the summer, Kansas joined our neighbors in Missouri, Nebraska, and Oklahoma in exempting Social Security income from state taxes. West Virginia is also phasing out Social Security taxation over the next two years.
So, if you're living in Colorado, Connecticut, Minnesota, Montana, New Mexico, Rhode Island, Utah, or Vermont – the only states that still tax Social Security – you have some new states to add to your list of potential tax-friendly relocation destinations.
Of course, no matter where you live or how large your nest egg is, Social Security is just one part of your retirement tax picture that should be carefully analyzed and coordinated with the rest of your comprehensive financial plan. Come visit Keen Wealth and we’ll talk about the timing, taxes, and best uses for your hard-earned benefits.
About Bill
Bill Keen is a financial advisor with over 30 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he focuses on providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to Forbes, U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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