How to reduce the taxes on your Social Security benefits

Taxes are a certainty in life, including when it comes to your Social Security benefits.

If you receive a monthly benefit check, chances are good that the income is taxed. In fact, the majority of Social Security recipients pay income tax on some of that income.

But if you don’t use strategies to manage your income, you could increase that tax bill. And that could mean a drop in retirement income.

William Meyer, founder of Social Security Solutions, a provider of claims software, estimates that, on average, you can make up to 7 years more money by creating withdrawal strategies tax-efficient money to coordinate Social Security benefits.

And those savings can run into the hundreds of thousands of dollars, according to Meyer.

“It brings in a lot of money for most people,” says Meyer. “It doesn’t matter how much or how little money.

“That savings can be substantial.”

According to the Social Security Administration, about 40% of people who receive Social Security benefits pay federal income tax on that income.

If your income is low enough, none of your Social Security earnings can be taxed. But there are two additional tax tiers, which means 50% or 85% of your benefits could be subject to federal taxes.

To know where you fall, you need to know your “temporary” or aggregate income.

To calculate that, add up your adjusted gross income plus untaxed interest plus half of your Social Security benefits. Those values ​​can be found on your 1040 tax form.

If you file as an individual, you are taxed up to 50% of your Social Security benefits if your gross income is between $25,000 and $34,000. But if you have gross income over $34,000, up to 85% of your benefits are subject to income tax.

If you’re married and filing together, those thresholds for combined income are higher. You will be taxed up to 50% of your benefits if your income is between $32,000 and $44,000. That amount goes up to 85% of your benefit if your income is more than $44,000.

And if you’re married and filing separately, you can also pay taxes on up to 85% of your Social Security income. That’s what Joe Elsasser, president and chief executive officer of Covisum, a Social Security claims software company, calls “gotcha” for those taxpayers.

Many people know if they owe federal income tax on their Social Security income at tax time when they tally their Social Security benefits and other income statements.

Note, you may also face state taxes on your Social Security earnings, depending on where you live. Most states do not tax these benefits. But there are 13 states that do, though the rules for that vary from state to state. Those states are Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia.

If you’ve just added income on your April return now, it’s too late to reduce those Social Security taxes.

But it’s not too late to try to reduce the rate you’ll be taxed on your benefit income for the next tax year.

The thing you want to watch out for the most is what is known as a “torpedo”.

A tax storm occurs when there are sharp increases and decreases in the marginal tax rate due to the taxing of Social Security benefits. The marginal tax rate is the additional tax you pay on each additional dollar of income.

For example, a hypothetical single retiree receiving $30,000 per year in Social Security benefits, along with other earnings, could have a marginal tax rate of 0% if adjusted gross income their modifications amounted to $12,400, according to research published by Meyer.

But that number can increase to 15% for earnings between $12,400 and $18,750; 18% on $18,750 to $19,000; 22.2% on $19,000 to $34,568; and then up to 40.7% on earnings from $34,568 to $43,706. Beyond $43,706, the marginal tax rate could drop to 22%.

Meanwhile, how much of their Social Security benefits are taxed also rises with those thresholds, until 85% of their Social Security benefits are taxed at the revised adjusted gross income of 43,706. dollars.

But there are strategies to prevent those taxes from rising too high. According to Meyer, waiting to claim Social Security benefits as long as possible — until age 70 — is one. That’s because that can help boost Social Security income while reducing the amount you take from tax-deferred retirement accounts, such as a 401(k) plan.

Another strategy is to regulate the sources from which you derive your income.

One area to watch for is how drawing extra money from an individual retirement account can increase your tax bill.

If you’re in the 12% tax bracket and take an extra $1,000 from your IRA, you could therefore lose close to $500 in federal income taxes due to a “bad interaction” between Social Security, income, and taxes. ordinary income and capital gains, Elsasser said. “That shocked a lot of people,” said Elsasser.

To mitigate that, be aware of how your decisions can trigger higher tax rates.

“What you really want to do is change the mix of income you have to actually save money on taxes instead of just paying them upfront,” says Elsasser.

To help reduce capital gains, Elsasser suggests, you can choose to use more tax-efficient investments, such as exchange-traded funds, rather than mutual funds. Investment-only variable annuities can allow you to defer taxes until you withdraw your money, he said. However, the risk is that it could increase your ordinary income.

More from Smart Tax Planning:
Nine ways you can cut your tax bill in 2019
Winners and Losers of Trump’s Tax Cuts
How to get tax refund sooner

You can also look for losses to offset gains in a portfolio, says Elsasser.

You may also want to tap into non-taxable accounts, such as a Roth 401(k) or Roth IRA, that won’t count as ordinary income, Meyer says.

Even if you think you’re already at the top 85% on Social Security taxes, there are strategic moves you can make, says Meyer.

“Be very strategic about your withdrawal strategy,” says Meyer. “You can withdraw in a sequence so that your Social Security taxes are not taxed.”

For help, the best source to consult is a qualified financial advisor who can offer advice on both retirement income and taxes, he says.