How to Minimize Taxes on Your Social Security Benefits

It’s important to be aware that a portion of your Social Security benefits may be subject to taxation, with up to 85% potentially being taxable. However, there are strategies available to mitigate your tax exposure and optimize your Social Security benefits.

1. Stay informed about Social Security income thresholds

Social Security taxes are calculated based on your annual “combined income,” a figure determined using the following formula.

Adjusted Gross Income (AGI) + Non-Taxable Interest + ½ of Social Security Benefit = Combined Income

Your Adjusted Gross Income (AGI) encompasses earnings from all taxable sources, including wages, withdrawals from tax-deferred retirement accounts like traditional IRAs and 401(k)s, and taxable investment income such as stock dividends and interest from taxable accounts. It is important to note that although income from municipal bonds is free from federal and possibly state income taxes, it is factored in when calculating the taxable amount of Social Security benefits.

The table below illustrates Social Security tax responsibilities at different combined income levels.

2. Delay your benefits

If you possess supplementary retirement savings, contemplate utilizing them in the initial years of your retirement and deferring the commencement of Social Security benefits. By depleting other taxable assets, there is potential to diminish your overall income, consequently reducing the portion of Social Security subject to taxation. An additional advantage of postponing the initiation of Social Security payments is the prospect of receiving an augmented monthly benefit. Each year of postponement beyond the full retirement age (up to age 70) contributes to an increase of up to 8% in your benefits, accompanied by greater adjustments for cost-of-living.

3. Consider a Roth conversion

Withdrawals from tax-deferred accounts, including traditional IRAs and 401(k)s, contribute to your Adjusted Gross Income (AGI) since these assets have not undergone taxation previously. In contrast, withdrawals from Roth sources are exempt from taxes as contributions to these accounts are made using after-tax funds.

In the pre-retirement years, considering the conversion of a portion of your tax-deferred assets to a Roth IRA may be a prudent move. Undertaking a Roth conversion involves paying taxes in the present year on any sum withdrawn from a traditional IRA to fund the Roth IRA. This significant tax event requires careful execution to avoid unintended consequences. Seeking guidance from a qualified wealth manager becomes crucial for determining the optimal timing and approach tailored to your specific financial circumstances. The advantage of this strategy lies in the continued growth of funds within the Roth IRA post-conversion, enabling withdrawals as retirement income without elevating combined income and, consequently, exposure to Social Security taxes.

4. Engage in qualified charitable distributions (QCDs)

Should your retirement objectives involve contributing to charitable causes, contemplating a direct donation from your IRA to a charity is advisable. This approach, known as a Qualified Charitable Distribution (QCD), may reduce your taxable retirement income, thus lowering your Social Security taxes.

Upon reaching the age of 73, it becomes obligatory to initiate required minimum distributions (RMDs) from your tax-deferred retirement accounts. Instead of receiving the distribution in your name, where it would contribute to your combined income for Social Security considerations, you have the option to designate the distribution directly to your selected charitable organization up to a maximum of $100,000 (indexed for inflation starting in 2024). Adopting this method not only reduces your taxable income but also allows you to amplify your charitable influence by contributing funds on a pre-tax basis. This approach represents a mutually beneficial outcome for both you and the chosen charity.