Avoiding Tax on Your Social Security Benefits

TaxingSocialSecurityUnderstanding how Social Security benefits are taxed has always been a question on many retirees’ minds. As you might have guessed with the complicated tax code, the tax on your Social Security benefits can vary greatly. Did you know that up to 85% of you benefit could be taxed depending on how much income you have?

  • If you are married and filing a joint tax return and your combined income is between $32,000 and $44,000, upwards of 50% of your Social Security benefits may be taxable. If you have income greater than $44,000, up to 85% of your benefits may be taxable.
  • For single filers that have income between $25,000 and $34,000, upwards of 50% of your Social Security benefits may be taxable. If you have income greater than $34,000, up to 85% of your benefits may be taxable.

What Qualifies as Income?

According to the IRS, income is defined as wages from a job or self-employment, interest, dividends and other income, including but not limited to traditional IRA distributions. So what are some techniques you could use to avoid paying tax on your Social Security benefit but still live comfortably?

Delay Taking Social Security: Delaying Social Security and drawing down your retirement accounts serves two purposes. First, your monthly Social Security benefit will increase and second, your required minimum distributions (RMDs) will be lower because you have reduced the balance of these accounts. A smaller RMD means less income and a lower probability of having your Social Security benefits taxed at a high rate.

Convert to a Roth IRA: Income from a Roth IRA is nontaxable and therefore won’t affect your benefits. Of course, if you convert a traditional IRA to a Roth IRA, you have to pay tax on any amount that is converted. Because of this, you advisor should run calculations to be certain this makes sense for you.

Convert Your Income: If you earn dividends from investments or own certificates of deposit, you may want to consider changing those investments to ones that don’t pay interest or dividends since both of these count as income. You need not worry about capital gains from investments since the IRS does not count this as income.

Before doing anything, you will want to sit down with your advisor to review your individual situation, because your situation is unique to you and these are complicated conversions that don’t make sense for many investors. By talking with your advisor they can review your income and financial goals to determine the best course of action for you.

About Chas Boinske

Charles P. Boinske, CFA, is a 30 year investment management veteran overseeing the strategic direction and portfolio management process for Independence Advisors, LLC. Have a question for Charles? CLICK HERE TO ASK CHARLES

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