Social Security: 3 Ways to Pay Less Income Tax on Your Benefits

Social Security: 3 Ways To Pay Less Income Tax On Your Benefits

Most people collecting Social Security rely on the program for a big part of their retirement income. So it’s not surprising that when many hear that the IRS might be in line to take back a portion of their monthly Social Security checks, they’re pretty unhappy and ready to do just about anything they can to avoid it.

Not all Social Security benefits are subject to federal income tax; you’ll never have to pay taxes on 100% of what you get from the program. Moreover, by taking some prudent steps, you might be able to reduce or even eliminate your tax bill on your Social Security. Later in the article, you’ll learn three ways to ease the tax burden on your benefits, but first, here’s how Social Security works with income tax rules.

The framework for income taxes on Social Security benefits

The key to determining whether you’ll owe tax on a portion of your Social Security checks is what’s called provisional income. Take your gross income, add in tax-exempt interest, and then add one-half of your total Social Security payments for the year. If that figure is above $25,000 for singles or $32,000 for joint filers, you’ll potentially owe tax on at least part of what you get from Social Security.

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Exactly how much gets added is complicated, as it depends on how far your provisional income exceeds those thresholds. From $25,000 to $34,000 for singles and $32,000 to $44,000 for joint filers, the maximum included amount is 50% of your benefits. Above those higher thresholds, up to 85% of your benefits can get taxed.

So, with that background, here’s how you can ease the blow and pay less to the IRS.

1. Control your capital gains and harvest your losses

During bull markets, the capital gains that retirees can generate when they sell investments to cover living expenses can be a big contributor to getting more of their Social Security taxed. For every $1,000 in additional capital gains you have, you could potentially add $500 to $850 to the amount of your Social Security benefits that you’ll have to include as taxable income.

If you can avoid those gains or defer them to another year, it could help you avoid paying more taxes on your benefits. Moreover, if you can harvest capital losses on losing investments, it could help offset not only gains on other investments but also up to $3,000 of other types of income each year. That could end up saving you hundreds of dollars in taxes.

2. Giving away your required minimum distributions — if you’re 70 1/2 or over

One problem many older retirees face is that traditional IRAs and 401(k) plans force them to take required minimum distributions (RMDs) from their retirement accounts. Those RMDs can often be the decisive factor in pushing provisional income above the taxation threshold for Social Security benefits.

Most of the time, charitable gifts won’t reduce your provisional income because most people have to itemize their charitable deductions. However, those 70 1/2 or older can make qualified charitable distributions (QCDs) of up to $100,000 per year from their retirement accounts. Unlike most distributions of RMD amounts, using QCDs means RMD income never hits your taxes in the first place. That, in turn, can keep your provisional income lower than it otherwise would be, saving you on Social Security-related income taxes.

3. Balance retirement distributions across Roth and regular accounts

Lastly, those fortunate enough to have both traditional and Roth-style retirement accounts can control their provisional income by planning their distributions from both types. Roth distributions don’t count toward provisional income, so taking more from a Roth in a given year can reduce the amount of your Social Security that gets taxed.

Nobody wants to pay more tax than they have to, and having your hard-earned Social Security benefits go to the IRS adds insult to injury. By following these three suggestions, though, you might be able to pay less in income taxes on your Social Security.

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