Strategies for Evading Taxes on Social Security Earnings
Minimising Taxes on Social Security Income: Key Strategies for Retirees
Managing your adjusted gross income (AGI) and provisional income is crucial to minimising taxes on your Social Security income. Here are some strategies retirees can consider to reduce their tax liability:
1. Reduce taxable income by moving income-generating assets into IRAs: Selling assets that produce taxable interest or dividends in taxable accounts and buying them inside an IRA can help lower your current taxable income. Meanwhile, place growth stocks in taxable accounts to defer capital gains taxes until sale, thus lowering current taxable income without reducing total cash flow.
2. Practice tax-efficient withdrawal strategies: Using withdrawals from Roth IRAs (which are generally tax-free) before traditional IRAs can keep your taxable income lower. Balancing withdrawals between tax-deferred and tax-free accounts can reduce your AGI and the taxable portion of Social Security.
3. Consider Roth IRA conversions strategically: Converting some traditional IRA funds to a Roth IRA in years when your income is relatively low can reduce future required minimum distributions (RMDs) that raise AGI and Social Security taxability later.
4. Use qualified charitable distributions (QCDs): If over 70½, donating directly from your IRA to charity can lower your AGI without requiring itemization, helping maintain lower taxable income thresholds for Social Security.
5. Manage timing of income events and Social Security claiming: Avoid large lump sums of income in one year by spreading out sales or other income to keep combined income below taxable thresholds. Consider delaying Social Security benefits until your income is lower to reduce or eliminate taxes on benefits.
6. Reduce business or earned income: Since combined income includes wages and business income, reducing earnings can also lower provisional income and the tax impact on Social Security.
7. Monitor and stay below key income thresholds: For single filers, no Social Security tax applies if combined income is below about $25,000; for married filing jointly, it's below $32,000 (varies slightly by source). Above these, up to 50-85% of benefits may be taxable.
In summary, minimising taxes on Social Security mainly involves reducing AGI and taxable investment income through smart asset placement (IRA vs taxable accounts), tax-efficient withdrawals, Roth conversions, charitable giving, and managing income timing and work earnings to remain below tax thresholds on benefits. Consulting a tax professional can help tailor these strategies based on your specific financial situation.
It's important to note that the Social Security Administration sends a benefit statement at the end of each year, showing what was received during the year, which can be used to determine how much of the benefit is taxable. However, with Social Security benefits rising in 2024 and 2025, while the tax-free thresholds remain the same, it may become harder to avoid paying taxes on the benefit checks.
When moving assets to an IRA, it's important to avoid incurring unnecessary capital gains taxes in the taxable account. Also, consulting with a tax professional is recommended when bunching deductions and expenses into alternating years to minimise Social Security income taxability. Lastly, money withdrawn from traditional IRA or traditional 401(k) increases adjusted gross income.
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