Savvy retirees can slash taxes on their Social Security benefits through strategic income management, potentially saving thousands of dollars annually—but only if they understand the complex thresholds and planning opportunities.
At a Glance
- Social Security benefits become taxable when your “combined income” exceeds certain thresholds: $25,000 for singles and $32,000 for married couples filing jointly
- Up to 85% of Social Security benefits may be taxable for higher-income retirees, but careful planning can reduce or eliminate this tax burden
- Roth IRA withdrawals don’t count toward the income formula that determines Social Security taxation
- Strategic income timing, charitable giving, and tax-loss harvesting can help keep more Social Security benefits tax-free
Understanding When Social Security Benefits Become Taxable
Many retirees are surprised to discover their Social Security benefits might be subject to federal income tax. The taxation formula hinges on what’s called your “combined income,” which includes your adjusted gross income (AGI), any non-taxable interest you receive, plus half of your Social Security benefits. The thresholds that trigger taxation haven’t been adjusted for inflation since they were established in the 1980s, causing more retirees to face this tax burden each year.
For single filers, combined income between $25,000 and $34,000 makes up to 50% of benefits taxable. Exceed $34,000, and up to 85% becomes taxable. For married couples filing jointly, the thresholds are $32,000 to $44,000 for the 50% level, and over $44,000 for the 85% level. Married couples filing separately face the strictest rules, with benefits potentially taxable regardless of income level.
“Therefore, the secret is to reduce your adjusted gross income in order to prevent provisional income from triggering a tax on Social Security,” says Kelly Crane, CFP, CLU, CFA, MBA.
Leveraging Roth Accounts to Minimize Taxable Income
One of the most powerful strategies for avoiding taxes on Social Security benefits involves Roth IRAs. Unlike traditional IRA withdrawals, Roth distributions are tax-free in retirement and don’t count toward your combined income calculation. This creates an opportunity to receive substantial retirement income without triggering Social Security benefit taxation. For those who haven’t saved in Roth accounts throughout their working years, Roth conversions before or during early retirement can be beneficial.
Converting traditional IRA or 401(k) assets to Roth accounts requires paying taxes on the converted amount in the year of conversion. While this creates an immediate tax bill, it can lead to significant long-term tax savings. The ideal time for conversions is often during the window between retirement and before claiming Social Security benefits, when your income might be temporarily lower.
Here's how a tax withdrawal could look like to pay $0 in taxes for a couple looking to early retire:
1. Withdraw $29,200 from your tIRA/401(k) using either the Rule of 55 or establish substantially equal periodic payments (Section 72(t) of the IRS). Since the withdrawal equals…
— The Money Cruncher, CPA (@money_cruncher) September 30, 2024
Income Management Strategies for Lower Taxes
Beyond Roth accounts, several other techniques can help keep your combined income below the taxation thresholds. Carefully managing withdrawals from traditional retirement accounts is essential since these distributions count toward your AGI. Consider withdrawing just enough to meet your needs while staying below tax thresholds, or coordinate your withdrawals strategically across different types of accounts.
“Reduce any K-1 or pass-through income from a business by increasing business deductions or expenses,” suggests Kelly Crane, financial advisor.
For those over 70½, qualified charitable distributions (QCDs) allow you to donate up to $100,000 annually from your IRA directly to charity. These donations can satisfy required minimum distributions without increasing your AGI. Additionally, moving income-producing investments like dividend stocks or bonds into tax-deferred accounts can help reduce taxable investment income that might push you over the threshold.
If you're a business owner, you can pay your children $13,850 (tax-free) and deduct it from your own taxes (legally).
By doing this, you can legally reduce your taxable income by $13,850 and avoid paying tax on that amount, plus your child will owe $0 taxes on that amount, and…
— Andrew Lokenauth | TheFinanceNewsletter.com (@FluentInFinance) November 14, 2023
Advanced Tax Planning Considerations
Tax-loss harvesting presents another opportunity to manage your income levels. By selling investments that have declined in value, you can offset capital gains and potentially reduce your AGI by up to $3,000 annually against ordinary income. This strategy works best as part of a comprehensive approach to portfolio management rather than as isolated transactions solely for tax purposes.
State taxation of Social Security benefits varies significantly, with some states fully taxing benefits while others provide complete exemptions. Understanding your state’s tax treatment is crucial, as moving to a more tax-friendly state could potentially save thousands of dollars annually for those with flexibility in their retirement location.
“Tax strategy should be part of your overall financial planning,” notes Kelly Crane, financial advisor.
While tax minimization is important, financial experts caution against making decisions solely to avoid taxes. The goal should be maximizing overall retirement security and income, not just minimizing the tax bill. About 60% of Social Security recipients already pay no federal taxes on their benefits, but this often correlates with having lower overall retirement income—not necessarily an ideal outcome. Consider working with a financial advisor who specializes in retirement tax planning to develop a personalized strategy that balances tax efficiency with your broader financial goals.
