In This Video:

Yes, you read that right.  There are taxes on your Social Security benefits.  How much?  Well, that depends on your combined income.  In this post and video, I discuss how to determine how much of your Social Security benefit is taxable.  Also, potential ways to reduce the taxes on your Social Security benefit.

Things To Consider:

Taxes on Social Security Benefits

One of the most frustrating taxes I hear about from those in retirement are the taxes on Social Security Benefits.  However, with some planning, there may be ways to potentially reduce or eliminate the tax.  First, let’s discuss how to determine if your Social Security Benefit will be taxable.  Once you have the formula down, we’ll talk about ways to potentially reduce the tax.

Will You Pay Taxes on Your Social Security Benefit?

Figuring Combined Income

Whether or not you will pay tax on your social security benefit is all based on your annual combined income.  Here’s the formula for determining combined income:

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Adjusted Gross Income (AGI) is your gross income minus any adjustments.  Examples of gross income are wages, dividends, capital gains, business income, and retirement distributions.  Examples of adjustments would be educator expenses, student loan interest, alimony payments, and retirement account contributions.

Nontaxable interest would be interest you’ve received from municipal bonds or municipal bond funds.

Once you know your combined income, you can use the thresholds determined by the IRS to determine how much of your Social Security will add to your taxable income

Thresholds and Taxable Social Security Benefits

How much of your social security adds into your taxable income is based on your combined income and if you are filing a single return or a joint return.  The rate is a progressive rate depending on where you fall in the chart.

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Strategies to Help Reduce Taxes on Social Security Benefits

Combined income is the driver of how much is taxable. The more combined income, the more tax you will pay.  Let’s revisit the formula and discuss some potential strategies to reduce the tax.

Combined Income Formula

As you can see from the formula, the main ways to reduce your combined income would be to reduce your nontaxable interest or reduce your AGI.

For most people in retirement, most of the AGI will be coming from 401(k) and IRA withdrawals or the required minimum distributions from these accounts.

A few strategies to potentially lower your combined income

Contribute to a Roth 401(k) or Roth IRA instead of the Traditional 401(k) and IRA

By contributing to these accounts, your money grows tax-free and you can make withdrawals tax-free.  The withdrawals from Roth 401(k)s and Roth IRAs are not considered adjusted gross income, therefore potentially helping to lower that line item in your formula during retirement.

Roth Conversions

By converting some or all of your 401(k) / IRA money to Roth, you would be eliminating some or all of the future withdrawals that you would have to take from those accounts.  Don’t forget, when you do a conversion, you pay tax on the money when you convert it.  You may have an upfront AGI that is higher in the years you are converting.  However, it may help you reduce your AGI in your future.

Tax Deferral of Dividends and Interest

Depending on how much in dividends, interest, and nontaxable interest your non-retirement accounts are generating, you could also consider tools to defer the taxes on these listed items.  One example would be placing these funds into an annuity.  Before doing so, it’s important to understand how using these tools may change the taxation of future withdrawals from the account.

If you’ve saved a healthy amount into your retirement accounts, frankly, the taxes on your Social Security benefits may not be avoidable.

Wrap-Up

For all the strategies, I recommend having a focus that is greater than just the taxes on Social Security benefits.  Considering your taxable income today vs. your taxable income in the future.  As well as where you feel tax rates will be today vs. the future.  Having an income plan in place can help you forecast these items and determine which strategies may or may not be a good fit for you.

Please remember that converting an employer plan account to a Roth IRA is a taxable event. Increased taxable income from the Roth IRA conversion may have several consequences including (but not limited to) a need for additional tax withholding or estimated tax payments, the loss of certain tax deductions and credits, and higher taxes on Social Security benefits and higher Medicare premiums. Be sure to consult with a qualified tax advisor before making any decisions regarding your IRA. 10022817 – 8/21