Most people who collect Social Security rely on the program for a large portion of their retirement income. So it’s not surprising that when many hear that the IRS might be lining up to take back some of their monthly Social Security checks, they’re pretty unhappy and willing to do just about anything they can to avoid it. .
Not all Social Security benefits are subject to federal income tax; you never have to pay taxes on 100% of what you get out of the program. Plus, by taking some prudent steps, you may be able to reduce or even eliminate your Social Security tax bill. 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 owe taxes on any portion of your Social Security checks is what’s called preliminary income. Take your gross income, add tax-free interest, then add half of your total Social Security payments for the year. If that figure exceeds $25,000 for singles or $32,000 for joint filers, you may owe taxes on at least a portion of what you get from Social Security.
Exactly how much is added is complicated, as it depends on how far your preliminary income exceeds those thresholds. From $25,000 to $34,000 for singles and $32,000 to $44,000 for joint petitioners, the maximum amount included is 50% of your benefits. Above those higher thresholds, up to 85% of your benefit can be 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 reap your losses
During bull markets, the capital gains retirees can generate when they sell investments to cover living expenses can go a long way toward paying more taxes on their Social Security benefits. For every $1,000 in additional capital gains you have, you may be able to add $500 to $850 to the amount of your Social Security benefits you must include as taxable income.
If you can avoid or defer those gains to another year, you can avoid paying more tax on your distributions. Additionally, if you can reap capital losses on losing investments, it can help offset not only gains on other investments, but up to $3,000 in other types of income each year. That can save you hundreds of dollars in tax.
2. Giving away your required minimum benefits — if you are 70 1/2 or older
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 deciding factor in pushing preliminary income above the tax threshold for Social Security benefits.
Most of the time, charitable giving will not reduce your provisional income because most people need 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 RMD income distributions, using QCDs means that RMD income never hits your taxes in the first place. That, in turn, can keep your preliminary income lower than it otherwise would be, saving you on Social Security-related income taxes.
3. Retirement benefits balance on Roth and ordinary accounts
Finally, those lucky enough to have both traditional and Roth-style retirement accounts can control their provisional income by planning their distributions from either type. Roth benefits don’t count toward preliminary income, so taking more of a Roth in a given year could lower the amount of your Social Security tax that’s taxed.
No one wants to pay more tax than they have to, and if your hard-earned Social Security payments go to the IRS, it’s even worse. By following these three suggestions, you may be able to pay less income tax on your Social Security.