How to Minimize Taxes on Social Security
Many retirees are surprised to find that up to 85% of their Social Security benefits could be taxable. But with the right planning, it's possible to reduce or even eliminate those taxes.
The IRS determines how much of your Social Security is taxable using your provisional income, which includes:
Your adjusted gross income (AGI)
Plus any tax-exempt interest (such as from municipal bonds)
Plus 50% of your annual Social Security benefit
Example:
If your AGI is $20,000, you receive $5,000 in municipal bond interest, and your annual Social Security benefit is $30,000, your provisional income would be $40,000 — putting you in the 50% taxable range if you file your taxes married filing joint.
Based on this calculation, here are the income thresholds that determine how much of your benefit is taxable:
Single filers
$25,000 to $34,000 in provisional income: up to 50% of benefits may be taxable
Over $34,000: up to 85% may be taxable
Married filing jointly
$32,000 to $44,000 in provisional income: up to 50% of benefits may be taxable
Over $44,000: up to 85% may be taxable
Note: This doesn’t mean your benefits are taxed at 85%. Rather, it means up to 85% of your benefit amount is included in your taxable income and taxed at your ordinary income tax rate.
Strategies to Reduce or Eliminate Social Security Taxes
1. Delay Taking Social Security
Delaying benefits until age 70 not only increases your monthly payout, but also creates an income “gap window” where you can take advantage of other planning opportunities — such as Roth conversions — before your benefit starts impacting your tax return.
2. Draw Down Pre-Tax Assets Before Claiming
In the early years of retirement, before beginning Social Security, consider withdrawing from traditional IRAs or 401(k)s. These distributions are taxable now, but doing so may reduce your future required minimum distributions (RMDs), which in turn lowers taxable income once you begin collecting Social Security.
3. Consider Roth Conversions
Similar to item 2, Roth conversions allow you to shift money from a traditional IRA to a Roth IRA, paying tax now in order to avoid higher taxes later. By shifting money from a Traditioanl IRA to a Roth IRA prior to starting your social security benefit, it may keep you in lower tax brackets in future years especially when RMDs (requirement minimum distribution) begin at age 73 or 75. Also, once in a Roth IRA, future withdrawals are tax-free and do not count toward provisional income — helping keep more of your Social Security sheltered from taxation.
Note: Keep in mind that conversions count as income in the year they’re done — and can impact provisional income temporarily.
4. Use Qualified Charitable Distributions (QCDs)
QCDs allow individuals age 70½ or older to donate up to $100,000 per year directly from an IRA to a qualified charity. These donations count toward your RMD but are excluded from taxable income.
Clarification: The $100,000 QCD limit applies per individual IRA owner — so a married couple could potentially exclude up to $200,000 in charitable distributions if each spouse qualifies.
This is another way to reduce the size of a pre-tax retirement account balance which counts toward the RMD calculation. Also since the QCD counts toward the RMD amount it can reduce your taxable income, potentially making less of your Social Security benefit subject to taxation at the federal level.
Example: Sue is 78 and is required to take RMD from her traditional IRA of $10,000. Sue decides to process a QCD from her IRA sending $10,000 to her church. She has met the RMD requirement but the $10,000 does not represent taxable income to Sue. Sue’s provision income as a single filer is $30,000 making her Social Security benefit 50% taxable. If she did not process the QCD, that would have raised her provisional income to $40,000 making 85% of her social security benefit subject to taxation.
5. Be Cautious With Tax-Free Interest
Although interest from municipal bonds is federally tax-exempt and potentially state income tax, it is included in the provisional income calculation. If your portfolio includes significant tax-free bond income, it could unintentionally push you into the 50% or 85% taxable Social Security range.
Final Thoughts
Social Security is a cornerstone of retirement income, but managing how it’s taxed is just as important as deciding when to claim. The key to minimizing Social Security taxes is planning around when you claim benefits and where your income is coming from. Strategies like Roth conversions, QCDs, and pre-Social Security IRA withdrawals can all work together to help you keep more of your benefits.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Frequently Asked Questions (FAQs):
How does the IRS determine how much of my Social Security is taxable?
The IRS uses your “provisional income” to determine taxation, which includes your adjusted gross income (AGI), tax-exempt interest, and 50% of your annual Social Security benefits. Depending on your filing status and total provisional income, up to 50% or 85% of your Social Security benefits may be taxable.
What are the income thresholds for Social Security taxation?
For single filers, provisional income between $25,000 and $34,000 makes up to 50% of benefits taxable, and income above $34,000 makes up to 85% taxable. For married couples filing jointly, the 50% range applies between $32,000 and $44,000, with anything above $44,000 potentially making up to 85% taxable.
Does “85% taxable” mean I pay 85% tax on my benefits?
No. It means that up to 85% of your Social Security benefit is included in your taxable income and taxed at your ordinary income tax rate. You’re not taxed at 85%; rather, that portion is subject to your regular tax bracket.
How can I reduce or avoid taxes on my Social Security benefits?
You can lower taxable income by delaying Social Security, making Roth conversions before claiming benefits, or drawing down pre-tax accounts early in retirement. Using qualified charitable distributions (QCDs) from IRAs after age 70½ can also reduce taxable income and lower how much of your benefit is taxed.
How do Qualified Charitable Distributions (QCDs) affect Social Security taxation?
QCDs let you donate up to $100,000 per year directly from an IRA to a charity, satisfying required minimum distributions (RMDs) without increasing taxable income. By lowering your income, QCDs can reduce the portion of your Social Security benefits subject to tax.
Does tax-free interest from municipal bonds affect Social Security taxation?
Yes. Although municipal bond interest is exempt from federal income tax, it is included in the provisional income formula. Large amounts of tax-free interest can unintentionally increase the taxable portion of your Social Security benefits.
