Advertisement
social security

Strategies to Reduce Taxes on Social Security

Tax planning may ease the tax bite on your benefits.

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.

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.

Advertisement - Article continues below

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.

Advertisement
Advertisement - Article continues below

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.

Advertisement - Article continues below

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.

Advertisement - Article continues below

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.

Haven’t yet filed for Social Security? Create a personalized strategy to maximize your lifetime income from Social Security. Order Kiplinger’s Social Security Solutions today.

Advertisement
Advertisement

Most Popular

Election 2020: Joe Biden's Tax Plans
taxes

Election 2020: Joe Biden's Tax Plans

With the economy in trouble, tax policy takes on added importance in the 2020 presidential election. So, let's take a look at what Joe Biden has said …
September 18, 2020
3 Reasons to Wait Until 70 to Claim Social Security Benefits
social security

3 Reasons to Wait Until 70 to Claim Social Security Benefits

In a rush to file for Social Security benefits at age 62? Many people are, but slow down and do the math first.
September 29, 2020
What to Do with Cash in a Low Interest Rate Environment
life insurance

What to Do with Cash in a Low Interest Rate Environment

Safe places to stash cash are earning next to nothing, so what can you do? Dividend-paying whole life insurance may be one option to consider.
September 30, 2020

Recommended

14 Social Security Tasks You Can Do Online
retirement

14 Social Security Tasks You Can Do Online

Why visit a government office to get your Social Security business done? You can do much of that online.
June 26, 2020
Medicare from Soup to Nuts
Healthy Living on a Budget

Medicare from Soup to Nuts

As you're signing up for Medicare, you must learn the basics of Medicare Part A, Part B, Part D, medigap plans, Medicare Advantage plans and even doug…
September 30, 2020
3 Reasons to Wait Until 70 to Claim Social Security Benefits
social security

3 Reasons to Wait Until 70 to Claim Social Security Benefits

In a rush to file for Social Security benefits at age 62? Many people are, but slow down and do the math first.
September 29, 2020
Social Security Recipients, Veterans Must Act Now to Get Extra $500 Stimulus Check
Coronavirus and Your Money

Social Security Recipients, Veterans Must Act Now to Get Extra $500 Stimulus Check

The deadline for seniors and veterans to request an additional $500 stimulus check for a dependent child is approaching fast. See how you can claim yo…
September 25, 2020