How much is social security taxed is one question that’s a bit different for everyone. Social Security income is taxed at the federal level and also taxed under some state jurisdictions. Anywhere from 0 to 85% of your Social Security income is taxable depending on your provisional income. Your provisional income is adjusted gross income less Social Security income, plus interest income on any tax-free investments like muni-bonds, plus half of your Social Security income.
Listed below are 5 ways to lower your taxes on Social Security benefits:
1) Don’t Top the Social Security Income Threshold
Depending on your filing status and combined income, up to 85% of your Social Security benefits could be taxable. The government uses your tax filing status to determine the threshold.
- Single – Income under $25,000 = 0% of your benefits are taxable
- Single – Income between $25,000 and 34,000 = up to 50% of your benefits are taxable (note that it’s a gradual increase)
- Single – Income over $34,000 = up to 85% of your benefits are taxable
- Married – Income under $32,000 = 0% of your benefits are taxable
- Married – Income between $32,000 and $44,000 – up to 50% of your benefits are taxable
- Married – Income over $44,000 = up to 85% of your benefits are taxable
- Married but filing separately – No income threshold = up to 85% of your benefits are likely taxable
If you’re just collecting Social Security income and have no other income sources you likely won’t be taxed at all. This is the case for the majority of beneficiaries. Since your Social Security income is calculated in provisional income, you’d have to earn a combined $64,000 in Social Security income just to hit the first threshold ($64,000 / 2 – $32,000).
Since the average Social Security check is $1,404 per month of $16,848 per year, most people never have to think about the taxability of their income. You, however, are above average because you’re on this website. You likely have other sources of income set up for retirement like a 401(k), Roth IRA, and pension. You should ensure you’re not going over the thresholds unless it makes sense to. That’s where income structuring comes in.
2) Income Structuring
Income structuring is a pretty simple concept. You have different sources of income and you want to make sure you combine that income in a way that is most optimal. Optimal meaning the most beneficial to you. You wouldn’t withdraw more money from your traditional IRA if it’s going to put you in a very high tax bracket and you have a Roth IRA that has money in. All things equal, you should withdraw from your Roth IRA if you’re close to a higher tax bracket.
The best way to figure out how to structure your income is to come up with a long term plan. There are four main sources of income in retirement: Social Security, pensions & annuities, portfolio income, and employment income. You can plug in your expected income from each source annually, then compare your annual income to the tax brackets.
Here’s an example: Michelle earns $20,000 from Social Security, $10,000 from a pension, and needs another $30,000 in income for her portfolio. That’s a combined $60,000 in annual income which would normally put someone in the 25% tax bracket. However, retirement income is vastly different than earned income. Michelle has a lot of different tax-favored options at her disposal. She decides to withdraw $25,000 from her Roth IRA and $5,000 from her traditional 401(k). By structuring her income, Michelle’s taxable income drops to the 15% tax bracket and she also completely avoids paying tax on her Social Security income because her provisional income is now $25,000 (1/2 Social Security income of $20,000 + $10,000 pension income + $5,000 traditional 401(k) income).
You can see how making a couple of changes to your income sources can have a huge impact on the amount of taxes you’ll have to pay. Of course, the example above is very easy to understand. Structuring your retirement income in practice is much more complicated and could take the better part of a day to analyze correctly. It’s worth it.
3) Growth Tops Income
Regular readers know I love income investments. But sometimes it works better to invest in companies or funds that don’t pay dividends. It works best to invest for capital appreciation if you have too high an income and want to reduce your tax liability. Switching your investments from income to growth will reduce your tax liability on Social Security as well as in general.
Business equity is the holy grail of tax avoidance. Business owner’s can keep their money in the company and invest in projects year after year without taking income. You can be a business owner too by buying stock in various growth companies or companies that do not pay dividends.
Let’s use Berkshire Hathaway as an example. Berkshire (BRK.B) is one of the world’s largest businesses and one of the safest low-cost investments you can make. Let’s say a retired investor owns 1,000 shares of Berkshire at $200 per share. This investor doesn’t get paid dividend. Bummer. But wait, there’s a great reason why the company doesn’t pay dividends. Berkshire believes it is a better steward of capital than you are. So they hold on to the retained earnings instead of paying them out. They don’t spend them on lavish parties. Instead, they reinvest the capital into other companies and projects. Why is this good for you? It’s good because the price of the stock increases without any tax liability on the shareholder’s behalf.
Now the price per share of Berkshire is $250 and your holdings are now $250,000 instead of $200,000 and you didn’t have to pay tax! You only pay tax when you sell and only to the extent of your capital gains. This could help you plan your income and have a great deal of control of the timing of your taxes owed. Only pay taxes when decide to sell. And if you never sell then your kids can get your stock at the cost basis of the stock at your death. Still no taxes paid!
4) Offset Social Security Income with Deductions
This point is about reducing your tax liability by having some itemized deductions. I believe that a lot of retirees would be better suited by carrying a big long term mortgage in retirement. Now the interest deduction is not that great a deal but when you add up all your deductions (property taxes, healthcare costs, etc.) it has a real impact on your tax liability.
This is also why I believe it doesn’t always make sense to have all of your money in after-tax retirement accounts like Roth IRAs. It’s good to have some taxable accounts that you can offset against deductions. Why else would deductions have any value if not for having some taxable income to offset against. Think twice before you covert your entire traditional IRA to a Roth. You may not need to.
Make sure you have some deductions that offset your taxable income. It doesn’t have to be the mortgage interest one if you’re opposed to that. You have to use the tax code to your advantage and understanding deductions is a big part of that.
5)How Much is Social Security Taxed in My State: The Florida Maneuver
It’s known for sun and beaches but that’s not all Florida’s good for. They’re also well known to retirees because they’re a tax friendly state. I met a couple who worked their entire life in New York, a state with horrendous taxes all around. They were able to defer a great deal of income from New York state taxes because the husband was self-employed and had a SEP-IRA. They then moved down to sunny Florida and were able to get tax fee Social Security and withdraw from his SEP-IRA without having to pay state tax.
You don’t have to move to a different state in order to be taxed less (although I’m not opposed to that). Just knowing how your state taxes Social Security is half the battle. I shared how states tax Social Security income in #4 of this article. Most states don’t tax Social Security income but some do. Check out the color-coded map of the states for a quick reference of how much Social Security is taxed in your state.