Strategies to Reduce Taxes on Your Social Security Benefits

Strategies to Reduce Taxes on Your Social Security Benefits

Strategies to Reduce Taxes on Your Social Security Benefits.Social Security benefits were once tax-free but changed in 1983 when Congress decided to tax a portion of benefits for the highest-income recipients.

Strategies to Reduce Taxes on Your Social Security Benefits

Today, most Social Security beneficiaries have to pay federal income tax on at least some of their benefits. However, there are ways to reduce this tax burden.

Understanding Social Security Taxes

Social Security taxes are based on your annual “combined income,” which includes your adjusted gross income, nontaxable interest, and half of your Social Security benefits. For couples filing jointly, a combined income between $32,000 and $44,000 means up to 50% of benefits may be taxable, while higher combined incomes can result in up to 85% of benefits being taxable. Single filers may also pay tax on up to 50% of benefits within a certain income range.

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Defuse the Tax Torpedo

The unique way Social Security benefits are taxed leads to something known as the “tax torpedo,” causing a sharp rise in marginal tax rates followed by a decline. Many middle-income households can face marginal tax rates that are 50% to 85% higher than their regular tax bracket. Delaying the start of Social Security benefits can help mitigate this effect and save on taxes.

Contribute to a Roth

Having money in a Roth IRA or Roth 401(k) can help reduce taxes on Social Security benefits, as withdrawals from these accounts are tax-free in retirement and aren’t included in your combined income.

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Get Charitable with Your IRA

Once you’re 70 1/2, you can make qualified charitable distributions, which are tax-free donations from your IRA to a charity. These distributions don’t count in your combined income and can help reduce your overall tax liability.

Consider Other Ways to Reduce Distributions

Tapping into your retirement funds before being forced to do so through required minimum distributions (RMDs) can help prevent higher tax brackets and increased Social Security taxes. Roth conversions are another option to consider, as they can reduce future taxes in retirement.

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Reducing taxes on your Social Security benefits requires careful planning and consideration of various strategies, including delaying benefits, contributing to Roth accounts, making qualified charitable distributions, and managing retirement fund distributions. Consulting with a tax professional or financial planner can help you make informed decisions to optimize your retirement finances.

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