After a lifetime of paying taxes on wages and other income, many people enter retirement expecting their Social Security benefits to be tax-free, but that’s often not the case. For some retirees, Uncle Sam takes a hefty bite of those benefits. Fortunately, there are ways to lower the percentage of Social Security payments that are subject to federal tax.
Start with calculating the taxable amount by adding together 50% of your Social Security benefits, all tax-exempt interest and other items that make up your adjusted gross income (minus certain deductions like those for higher education). The result is your provisional income.
Social Security benefits are not taxed for single filers with provisional incomes of less than $25,000. The same is true for married couples filing jointly if their provisional income is less than $32,000. When provisional income is between $25,000 and $34,000 for a single filer, or $32,000 and $44,000 for a joint filer, up to 50% of Social Security benefits can be taxed. As much as 85% of those benefits are subject to tax when provisional income exceeds $34,000 on a single return or $44,000 on a joint return.
Reducing adjusted gross income is the key to lowering taxes on Social Security. If your AGI drops, so does your provisional income. When your provisional income shrinks, the percentage of benefits included in taxable income declines, lowering the tax on benefits.
Your strategy for reducing the tax should be put in place long before your first Social Security check arrives. Matt Nadeau, wealth adviser at the Piershale Financial Group in Barrington, Ill., often recommends pre-retirement Roth conversions. Shifting money from a traditional IRA to a Roth IRA generally makes sense, he says, because the Roth’s tax-free withdrawals won’t raise AGI.
Simply delaying Social Security can help. The longer you wait, the more you’ll get per month. “If your Social Security is higher and it allows you to take less from a retirement account like an IRA, that lowers provisional income” because you have less taxable money from a traditional IRA boosting your AGI, says Nadeau.
Once you start taking Social Security and are at least 70½ years old, qualified charitable distributions are a great way to cut taxes on those benefits if you are taking money from a traditional IRA and plan to give to charity anyway. With a QCD, you can transfer up to $100,000 directly from a traditional IRA to charity without raising your AGI, whereas if you took $1,000 from your IRA and donated it separately “that $1,000 might be making another $850 of your Social Security taxable,” warns Ryan McKeown, senior vice president at Wealth Enhancement Group in Mankato, Minn.
Tax-efficient investing can also help you keep more of your Social Security benefits. For example, because dividends are included in AGI, Nadeau suggests investing for growth rather than dividend income in after-tax retirement accounts. If you’re working part-time in retirement, which by itself will increase income, continuing to fund a traditional IRA helps dial back your AGI.
Monitoring the capital gains on your investments is also important, says McKeown. “Long-term capital gain is something people can control, because they make a choice to sell an investment.” Even if you qualify for the 0% tax rate on capital gains, McKeown warns, you could still be upping the tax on Social Security benefits by selling capital assets. One way around this is to sell some stocks at a loss, if you can, to offset capital gains.
“All the decisions need to be put in context of an overall plan,” notes McKeown. “Make sure that things make sense for your goals and have investment merit” because there’s more to sound financial planning than just lowering taxes.
Rocky Mengle was a Senior Tax Editor for Kiplinger from October 2018 to January 2023 with more than 20 years of experience covering federal and state tax developments. Before coming to Kiplinger, Rocky worked for Wolters Kluwer Tax & Accounting, and Kleinrock Publishing, where he provided breaking news and guidance for CPAs, tax attorneys, and other tax professionals. He has also been quoted as an expert by USA Today, Forbes, U.S. News & World Report, Reuters, Accounting Today, and other media outlets. Rocky holds a law degree from the University of Connecticut and a B.A. in History from Salisbury University.
How to Measure the Health of Your Retirement Plan
These five key indicators can help you make decisions based on the overall performance of your retirement plan rather than individual variables.
By Brian Skrobonja, Chartered Financial Consultant (ChFC®) Published
Four Easy Ways to Get Yourself Fired
Being a standout on the job can sometimes be as simple as showing up to meetings on time, responding promptly to requests, doing your homework and not being a jerk.
By H. Dennis Beaver, Esq. Published
Is a Medicare Advantage Plan Right for You?
Medicare Advantage plans can provide additional benefits beneficiaries can't get through original Medicare for no or a low monthly premium. But there are downsides to this insurance too.
By Jackie Stewart Published
What You Must Know About the Different Parts of Medicare
Medicare Medicare can be complicated but we've got you covered. Here is a quick guide to the different benefits provided through each part.
By Jackie Stewart Last updated
Retirees, It's Not Too Late to Buy Life Insurance
life insurance Improvements in underwriting have made it easier to qualify for life insurance, which can be a useful estate-planning tool.
By David Rodeck Published
Best Banks for Retirees
banking Kiplinger's 2023 list of the best banks for retirees.
By Lisa Gerstner Published
As the Market Falls, New Retirees Need a Plan
retirement If you’re in the early stages of your retirement, you’re likely in a rough spot watching your portfolio shrink. We have some strategies to make the best of things.
By David Rodeck Published
Retirees: Your Next Companion May Be a Robot
happy retirement Robots may help fill the gap left by a shortage of humans to help older adults live independently.
By Alina Tugend Published
Using Your 401(k) to Delay Getting Social Security and Increase Payments
retirement Your 401(k) can be a bridge from retirement to higher monthly income.
By Elaine Silvestrini Published
How Do I Stop Robocalls From Scamming Me?
retirement The scammers have automated their efforts to separate you from your money. We have ways to make it stop.
By Elaine Silvestrini Published