Making Your Money Last
Strategies to Reduce Taxes on Social Security
Tax planning may ease the tax bite on your benefits.
By Rachel L. Sheedy, Managing Editor, Kiplinger's Retirement Report
September 1, 2010
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You paid into the Social Security system all your life, but up to 85% of your benefits may be subject to federal tax. Tax planning can ease the pain.
SEE ALSO: 10 Tax-Friendly States for Retirees
The tax hit will depend on your income and marital status. First figure your modified adjusted gross income, which includes non–Social Security sources of taxable income, such as pensions, wages, interest and dividends. Add in tax-exempt interest and certain other exclusions from income. Itemized deductions won't help you in this calculation, says Robert Seltzer, a certified public accountant in Beverly Hills, Cal.
Next add one-half of the Social Security benefits you receive for the year -- the total is your "provisional income." Then look at the IRS's "base amounts" for taxing Social Security. The base amounts are $32,000 for married couples filing jointly and $25,000 for single filers.
If your provisional income exceeds the base amount, you will pay federal tax on your benefits. That's the case for many retirees who have investment income, a pension or rental income.
The percentage of benefits that are taxed depends on your income. Up to 50% of benefits are taxable when provisional income is between $32,000 and $44,000 for married couples filing jointly (for single filers, it's between $25,000 and $34,000). If provisional income is more than $44,000 (for singles, $34,000), up to 85% of Social Security benefits are taxable.
Say you're married filing jointly and your $42,000 in provisional income includes half of your $12,000 in Social Security benefits. Your provisional income exceeds the $32,000 base amount by $10,000.
The amount of benefits that will be included in your taxable income is either half your benefits ($6,000) or half the excess income over the base amount ($5,000) -- whichever is smaller. In this case, you'll include $5,000 of benefits in your taxable income. At a 15% tax rate, the tax on benefits would be $750.
Worksheets in IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits, will help you compute the tax. Check with your state's tax department to find out if your state taxes your benefits.
Strategies to Lessen the Tax Hit
To lower the tax, you have to reduce your overall taxable income. "If you're above the thresholds, you need to look at the components of your AGI," says Donald Pinkleton, a certified public accountant in Richmond.
Those who are on the borderline of the 50% and 85% thresholds can most easily make tax-saving moves. "Rule No. 1 is try to avoid spikes and bumps in income," says Pinkleton. If you've been under the 85% threshold, a hefty profit from a stock sale could boost your taxable income for the year. You might consider accelerating income into one tax year or pushing off income to another year. Another way to reduce taxable income: Boost pretax IRA and 401(k) contributions.
Thomas McCabe, a certified public accountant with Prestige Wealth Management Group, in Flemington, N.J., says paying off a mortgage with cash savings could preserve benefits from tax. Say a beneficiary has a mortgage and savings throwing off taxable interest. The mortgage interest deduction won't reduce the beneficiary's modified adjusted gross income. But using the cash to pay off the mortgage will lower taxable income in the benefit taxation calculation, McCabe says.
In the year you convert a traditional IRA to a Roth, your benefits will likely get taxed because a conversion adds to your taxable income. You might consider doing smaller conversions over several years in amounts that take you to the top of your current tax bracket.
Taking the one-time tax hit could be worth it. Withdrawals from a traditional IRA and 401(k) are counted as taxable income. By converting, you may eliminate or reduce the tax hit on future benefits. "Roth income is not counted in the Social Security taxation calculation," says Larry Rosenthal, president of Financial Planning Services, in Manassas, Va.
EDITOR'S NOTE: This article was originally published in the July 2010 issue of Kiplinger's Retirement Report. To subscribe, click here.
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Reader Comments (9)
Posted by: Bob at 09/02/2010 08:43:36 AM
Interest from tax deferred annuities does not count in the formula, so a person could move some of his/her taxable CD $ into an annuity to help. Rates on fixed annuities usually beat CDs of similar maturity periods, as well.
Posted by: Mark at 09/02/2010 05:34:19 PM
I believe we are looking at this backwards. No one is addressing the real problem with Social Security. It doesn't matter how much or how we put money into Social Security if we keep taking money out of it for other programs. We could tax it at 150% and raise the retirement age to 100 and it still not enough money for it. We need to first STOP taking money out of social security to pay for big government programs we can't afford. Then we can have a real conversation about how to solve it. We will never fill a can up with water if we keep poking more holes in the bottom. We are already abolishing SS by using up the money for other programs. In the end when it fails it becomes another tax not a safety net. The government doesn't want it privatized because it is hooked on spending the money in it. They think it is their money to spend. They have lost sight that it is our money to save.
Posted by: Enrolledagent at 09/03/2010 11:47:04 AM
The other way to possibly rectify this mess that Al Gore decided for us is to get legally divorced, and live together so you can get file as single. I will be doing this by the end of 2012 as that is when I first start receiving ss benefits.
Posted by: Angel Dayan, EA, CPA at 09/03/2010 12:03:19 PM
Taxing social security was Reaganomics. But he envigorated the economy in 2 terms. So it was okay for Americans. We do not need that now in a down economy, but who would change the law when social security feeds the money into the U.S. tax structure, more than income taxes. People's solution has been to dodge its payment that has now piled a huge uncollectible receivable inventory (billions) in the books. It is eroding our tax infrastructure daily. The problem is not moving resources to reduce taxable income base for social security benefits to be taxed, the problem is removing this tax created by Reaganomics that slid into the system and has now become permanent even in our recession economy. People in financial services may be moving marbles for commission but social security tax is here to stay until a lameduck congress wakes up and serve us from the tax code that punishes hard-saved retirement money at need time. Wake up Americans!
Posted by: jason at 09/03/2010 12:33:46 PM
For those who are interested here is a website that provides calculators to determine how much of your social security benefit is taxable & strategies to reduce the taxable amount of social security benefits. www.socialsecuritymax.com
Posted by: kenneth at 09/06/2010 05:56:07 AM
could someone adress this important issue with specific attention to a pensioner in a country where the tax is on eht individual, be they a wife, husband or single?
Posted by: Wendy B. at 09/06/2010 09:19:47 AM
I don't see too much of a problem with paying taxes on Social Security income, since we never paid taxes on it in the first place. As a matter of fact, we used social security to pay less taxes on our earned income while we were earning it. So you could say that we already received the tax breaks from Social Security and 401 K's etc. Maybe if our country's tax structure was based upon fairness for all, where the people who earn more pay more...a progressive tax structure, the government would receive enough tax dollars to operate without having to raid Social Security. In addition, especially in today's economy, Congress must exercise more fiscal responsibly by not spending money frivalously on things like corporate welfare, tax subsidies to multibillion-dollar corporations, and, on irresponsible wars that drain the nation's coffers and hurt so many of our families. Maybe a person retiring with a six-figure retirement benefit from pension systems other than Social Security, should not take social security payments. This system is already in place with public school teachers and other municipal employees who have paid into Social Security. Their retirement benefits are no where near a six-figure amount. Social Security is a retirement system with a guarunteed benefit at retirement. Do we really want to do away with our guaranteed benefit by privatizing S.S. and giving it to Wall Street? What would have happened with our S.S. benefit if we were supposed to retire, at age 67, two years ago? I don't relish the idea of having to work into my 70's because Wall Street played fast and frivilous with my social security.
Posted by: Escort Rider at 09/11/2010 11:02:41 PM
I think this is much ado about nothing for two reasons. First, even the maximum Social Security retirement benefit is not that much: $2,346 per month ($28,152 per year) for an individual, and most people are not drawing the maximum. Second, just go back and take a look at the formula in the article; the people who are paying income tax on their SS benefits can easily afford to do so. An interesting little side fact here: The taxes on our SS do not go into the general fund like our other income taxes, but rather back into the Social Security Trust Funds (up to 50% of benefits taxable) or into the Medicare HI (Part A) Trust Fund (51% to 85% of benefits taxable).
Posted by: Don P. at 09/16/2010 06:10:03 PM
I usually don't get into public discussion forums, but there are a number of inaccuracies in these comments. "I don't see too much of a problem with paying taxes on Social Security income, since we never paid taxes on it in the first place" is absolutely incorrect. On a W-2, for example, the Federal taxable income is never reduced by FICA taxes withheld. You pay income tax on the amount of social security taxes that were withheld. "Maybe if our country's tax structure was based upon fairness for all, where the people who earn more pay more...a progressive tax structure,..." I'll leave the "fairness" issue aside, but a quick look at the income tax rate tables will confirm that those who earn more pay more. A visit to the National Taxpayers Union website will show that the top 5% of taxpayers pay over 60% of income taxes, the top 10% pay over 70%. "Congress must exercise more fiscal responsibly by not spending money frivalously [sic] on things like corporate welfare, tax subsidies to multibillion-dollar corporations,..." We have the world's highest corporate tax rates, which is why corporations are fleeing the U.S. and taking jobs with them. And finally, "the people who are paying income tax on their SS benefits can easily afford to do so." Really? You know them all? Like the person who has $50,000 plus in annual medical expenses, a mortgage and a child in college? The Robin Hood mentality is destroying this country - the idea that we are justified in confiscating another's wealth simply because they have more? "Tax the rich, because that's where the money is?" That's the same thing Dillinger said about robbing banks.