Clever Ways To Avoid Taxes On Social Security Benefits
Last updated Aug. 25, 2022| By Lance Cothern| Edited ByMelinda Sineriz
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As long as you qualify for Social Security retirement benefits, you can start getting payments as early as age 62. The payments wont make you rich, but they provide income to help you meet your financial needs in retirement.
Although it may seem like Social Security benefits shouldnt be taxed, that isnt always the case. If your total income is high enough, you have to pay income tax on your Social Security benefits. You can make smart tax moves to avoid paying Social Security taxes, as long as you do so according to the rules. Learn what those moves are so you can minimize your taxes on Social Security benefits.
How Is Tax Calculated On Social Security Income
When it comes to social security income, the level of taxation is very similar to any other form of income someone may have. When an individual files taxes, they have to submit their adjusted gross income, which would include income from social security and all other forms of income they may have.
Now if that total adjusted gross income exceeds the threshold set forth by social security then at least 50% of your total social security benefits would be considered taxable income for the individual or couple filing.
This amount will be considered when filing your taxes so your accountant can figure out how much income tax you will need to pay.
If your total gross adjusted income does not exceed the threshold then it could be that none of your social security income would be considered taxable income.
Withdraw Taxable Income Prior To Retiring
There is another way you can easily minimize the amount of taxes you may have to pay on your social security payments, and that is to maximize or at least increase the taxable income you do have in the years before youre going to receive these benefits.
If you have traditional IRAs or 401s, you could start taking the funds out after age 59 ½ without being penalized for it, but you would increase your taxable income in those years. So if you are still working, and plan to be for a few more years after this age, then it may be a good way to use up your tax sheltered funds.
The idea behind this strategy is that you would be making more withdrawals from these accounts in your pre-social security days than you would be during the time you need these benefits.
You do not have to spend this money right away, but you should have a plan for withdrawing from a tax sheltered account so that you do not exceed what you can afford to pay in taxes during your working years.
As an added benefit to this strategy you can take this money out and tuck it away so that you have those funds available to you when you need them. With this in mind, you can potentially delay receiving your social security benefits too which means you can increase the size of the benefits you do get when you get them
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Is It Better To Take Ss At 66 Or 70
As you undoubtedly already are well aware, most financial planners recommend thatso long as you can afford to do soyou should wait until age 70 to begin receiving your Social Security benefits. Your monthly payment in such an event will be 32% higher than if you begin receiving benefits at age 66.
Taxes Don’t Need To Eat Away At Your Monthly Checks
Social Security benefits can go a long way toward helping you enjoy a more financially secure retirement. However, you may not collect as much as you think.
Your monthly checks are subject to both state and federal taxes, and these taxes can take a significant bite out of your benefits. If you’re going to be depending on Social Security to pay the bills in retirement, taxes could wreak havoc on your financial plans.
Fortunately, there are ways to avoid taxes on your benefits. With the right strategy, you may be able to get out of paying them altogether. Here’s how.
Image source: Getty Images.
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You May Have To Pay Taxes On Your Social Security Benefits
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You’ve reached the age when you can begin collecting Social Security. When tax time rolls around, you may be wondering if you have to pay income tax on your Social Security benefits. Unfortunately, the answer isn’t a simple yes or no. Your tax liability depends on other details about your situation. Social Security benefits might be either non-taxable or partially taxable.
Learn the factors that determine whether or not you’ll owe taxes on your Social Security benefits.
How Do I Determine If My Social Security Is Taxable
Add up your gross income for the year, including Social Security. If you have little or no income besides your Social Security, you wont owe taxes on it. However, if youre an individual filer with at least $25,000 in gross income, including Social Security for the year, then up to 50% of your Social Security benefits may be taxable. For a couple filing jointly, the minimum is $32,000. If your gross income is $34,000 or more , then up to 85% may be taxable.
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If You Earn Enough Money For Your Benefits To Be Taxable You Could End Up Paying The Highest Income Taxes In The Country
Social Security benefits are tax free unless you earn too much income during the year. To know whether you might be subject to such taxes you have to figure your “combined income.” This is actually quite easy: Simply add one-half of the total Social Security you received during the year to all your other income, including any tax-exempt interest .
You’ll have to pay tax on part of your benefits if your combined income exceeds these thresholds:
- $32,000 if you’re married and file a joint tax return , or
- $25,000 if you’re single.
If a married couple files their taxes separately, the threshold is reduced to zerothey always have to pay taxes on their benefits. The only exception is if they did not live together at any time during the year in this event the $25,000 threshold applies.
This applies to all types of Social Security benefits: disability, retirement, dependents, and survivors benefits.
How much of your Social Security benefits will be taxed depends on just how high your combined income is.
Individual filers. If you file a federal tax return as an individual and your combined income is between $25,000 and $34,000, you have to pay income tax on up to 50% of your Social Security benefits. If your income is above $34,000, up to 85% of your Social Security benefits is subject to income tax.
Once you start receiving Social Security benefits, to keep your income below the applicable threshold, or at least as low as possible, you should:
When Is The Federal Tax Deadline In 2022
If you have not filed your tax return, it is important to know that the deadline, Monday, April 18, 2022, is just around the corner.
Individual tax returns are typically due on April 15.
However, April 15, falls on a Friday this year, which is when Emancipation Day will be observed.
If do not think you will be able to meet the April 18th deadline, you may apply for a six-month extension, but extensions must be filed by April 18.
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Should You Avoid Paying Taxes On Social Security Benefits
You might be focused on how to avoid paying taxes on Social Security but its important to consider whether you should.
For example, say your initial goal is to begin taking benefits at age 62 while continuing to work part-time. Doing so would mean having to keep a close eye on your income from part-time work to ensure that you dont tip the threshold for having your benefits taxed. Youd also have to observe the annual earnings limits to avoid having your benefit amount reduced.
Its worth noting also that taking Social Security prior to reaching your full retirement age would reduce your benefit amount. So, by working and receiving benefits early, you could effectively ding yourself financially three times over through benefit reductions and having to pay taxes on them.
When determining ways to avoid paying taxes on Social Security, its important to consider the bigger tax picture. That includes where withdrawals from both tax-advantaged retirement accounts and taxable brokerage accounts fit in. Its also important to consider your timing when taking benefits. If youre able to delay Social Security to age 70, for example, you could get 132% of your benefit amount.
More On Social Security And Retirement
- Earning Income After Retiring: Collecting Social Security while working can get complicated. Here are some key things to remember.
- An Uptick in Elder Poverty: Older Americans didnt fare as well through the pandemic. But longer-term trends arent moving in their favor, either.
- Medicare Costs: Low-income Americans on Medicare can get assistance paying their premiums and other expenses. This is how to apply.
- Claiming Social Security: Looking to make the most of this benefit? These online tools can help you figure out your income needs and when to file.
One reason, experts say, is the roughly 77 percent boost in benefits a beneficiary receives by claiming at 70 rather than at 62.
Another is the difference in how I.R.A. withdrawals and Social Security benefits are taxed. Individuals pay the ordinary federal income tax rate on all I.R.A. withdrawals. But just 85 percent, 50 percent or none of their Social Security benefits are taxed.
The amount subject to tax depends on your provisional income, which includes half of benefits and 100 percent of nonbenefit income. The more I.R.A. income, the more likely you are to pay at a higher marginal rate and be taxed at the 85 percent threshold.
With this formula in mind, a new retiree should start I.R.A. withdrawals early, when the marginal rate is likely lower, said Laurence Kotlikoff, an economics professor at Boston University.
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Alternatives To A 401 Disability Withdrawal
There are several possible alternatives to a 401 disability withdrawal. You may want to consider other options because you dont qualify for a disability withdrawal or because other options simply work better for you.
- Withdraw funds from a Roth IRA: You can generally withdraw contributions you made to a Roth IRA at any time without owing taxes or penalties. You dont need a specific reason or any reason at all.
- Take a 401 hardship withdrawal: You can take a 401 hardship withdrawal for several types of financial hardships without needing to prove that youre disabled. However, a hardship withdrawal isnt available if youre not using the money to pay specified expenses or if you have other funds available.
- Take substantially equal periodic payments: Another option that doesnt require proof of disability and is common for early retirees is to take substantially equal periodic payments. Using an IRS formula, you can take annual payments that start to pay out your 401 before you reach retirement age. The downside to this option is that you usually need to commit to these payments for at least 5 years or until you turn age 59.5.
- Job loss after age 55: If you leave your job for any reason after you turn age 55, you can usually begin taking money out of your 401 without penalty. However, not all 401 plans support this option.
And then maybe in a future year, youll have taxable pension income so withdrawing from your Roth IRA will be better then.
Do I Have To Pay Taxes On Social Security
In short yes, but not everyone is going to pay the same amount of taxes. There are different levels of taxation depending on an individuals total income and how they file their taxes.
For example, for people who make a total gross income including their social security payments of $25,000 or more will be taxed up to 50% income tax on just their social security payment amounts.
If it is a couple who is filing, then the joint income total will be bumped up to $32,000.
If a single person is earning up to $34,000, or a couple is earning $44,000, then they could be taxed up to 85% of their social security payment amounts.
In most cases, those who have a very low total income household when they retire will be the only ones who are exempt from any form of tax on social security income tax.
An interesting point to note, though, is that social security payments have been subject to income tax payments since 1983. However, the threshold for those who have to pay the tax has not been adjusted since then so the majority of people who receive social security payments do end up paying some type of income tax on them.
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Can I Avoid Paying Taxes On Social Security
POSTED ON: March 3, 2022
Can I Avoid Paying Taxes on Social Security?
No one likes Social Security benefits being taxed. While a dozen states levy a tax on Social Security benefits, theres no getting away from federal income taxes. A recent article from Investopedia, Which States Dont Tax Social Security Benefits, explains it all.
If you really want to, it is possible to pay zero Social Security taxes. However, this requires staying below the minimum income threshold.
The twelve states that tax Social Security benefits are:
Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont and West Virginia.
Of these, only Minnesota and Utah add an additional Social Security tax using the same income thresholds as the federal government.
However, retirees are advised not to base their choice of retirement location just on this annoying tax. More important factors to be considered include your overall cost of living, quality of healthcare services, geographic proximity to family and friends, available recreational activities, crime rates and climate.
Social Security benefits taxes are not news. These benefits have been taxed since 1983. Taxes depend on the households combined income, aka Adjusted Gross Income , nontaxable interest and half of the couple or individuals Social Security benefits and filing status.
Taxes On Iras And 401s
Once you start taking out income from a traditional IRA, you owe tax on the earnings portion of those withdrawals at your regular income tax rate. If you deducted any portion of your contributions, you’ll owe tax at the same rate on the full amount of each withdrawal. You can find instructions for calculating what you owe in IRS Publication 590, Individual Retirement Arrangements.
If you have a Roth IRA, you’ll pay no tax at all on your earnings as they accumulate or when you withdraw following the rules. But you must have the account for at least five years before you qualify for tax-free provisions on earnings and interest.
When you receive income from your traditional 401, 403 or 457 salary reduction plans, you’ll owe income tax on those amounts. This income, which is produced by the combination of your contributions, any employer contributions and earnings on the contributions, is taxed at your regular ordinary rate. Keep in mind that withdrawals of contributions and earnings from Roth 401 accounts are not taxed provided the withdrawal meets IRS requirements.
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Dont Work Or Work Less In Retirement
Every dollar you earn doing part-time work can push you a little closer to owing taxes on your Social Security benefits. Of course, its silly to quit a job you enjoy or need simply to trim your tax bill.
But if the job is a low-wage pain in the neck that only provides you with a modest financial benefit, you might be better off at least emotionally quitting so that you can reduce your income for the tradeoff of lowering or eliminating taxes on your Social Security benefits.
Increased Income Threshold For Single Income Tax Filers In 2022 And 2023
These types of adjustments are typically made every year in order to avoid âbracket creep,â which refers to an increase in ones taxable income even when income has lost its purchasing power due to inflation.
If your income does increase, though, you might still owe the same amount or even more in income taxes going forward. With that in mind, you should consider taking steps to reduce the amount of tax that you owe.
In fact, careful tax planning could significantly reduce what you are required to pay even if you generate a fairly high amount of income. Some options here could include:
- Selling investments where you will have a loss
- Continuing to contribute to a traditional IRA and/or other traditional retirement plan
- Making deductible charitable contributions
Because Social Security is a major component of many retirees incomes, it is essential to try and reduce or eliminate taxes that you pay on this retirement cash flow source, too. So, what are ways to avoid taxes on Social Security benefits?
There are several strategies that you could use for reducing or possibly even eliminating taxes on your Social Security retirement income benefits. These may include the following:
- Moving income-generating assets into an IRA
- Shifting growth assets into taxable accounts
- Minimizing withdrawals from your traditional IRAs and retirement plans
- Ensuring that you are taking your maximum capital loss
- Reducing your business income
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