3 Ways to Reduce Social Security Taxes | ET REALITY


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Social Security benefits were once tax-free. That changed in 1983, when Congress decided to tax a portion of benefits for higher-income recipients.

At that time, less than 10% of beneficiaries were affected. But lawmakers didn’t update the law to account for inflation, so today most Social Security recipients have to pay federal income taxes on at least some of their benefits, says Ted Sarenski, author of the “Social Security Planning Guide” from the American Institute of CPAs. “

However, there are some ways to reduce that tax burden, especially if you can plan ahead.

How Social Security taxes work

Social security taxes They are based on your annual “combined income.” Combined income includes:

  • Your adjusted gross income, which includes your earnings, investment income, retirement plan withdrawals, and other taxable income.
  • Any nontaxable interest you receive, such as interest on municipal bonds.
  • Half of your Social Security benefits.

For couples filing jointly, a combined income between $32,000 and $44,000 means that up to 50% of the benefits may be taxable. For higher combined incomes, up to 85% of profits may be taxable. Single taxpayers can pay taxes on up to 50% of benefits when combined income is between $25,000 and $34,000, and up to 85% of benefits beyond that.

People who live solely on Social Security don’t have to pay income taxes on their benefits, Sarenski notes. But even a relatively small amount of other income can make the benefits taxable.

Deactivate the fiscal torpedo

The unique way Social Security benefits are taxed leads to something known as the “fiscal torpedo”: a sharp increase in marginal tax rates followed by a decrease, says William Reichenstein, a professor emeritus at Baylor University and co-author of “Social Security Strategies: How to Optimize Retirement Benefits.” Marginal tax rates are what you pay for each additional dollar of taxable income you receive.

Many middle-income households may face marginal tax rates that are 50% to 85% higher than their regular tax bracket because of this fiscal torpedo, Reichenstein says.

“If you take another dollar out of your tax-deferred account, another 85 cents will be taxed from Social Security, so your taxable income increases by $1.85,” he says.

Moderate-income households could mitigate the effects by delaying the start of Social Security benefits as long as possible, Reichenstein says. Someone who waits until age 70 to start receiving benefits and withdraws money from retirement funds in the meantime not only gets a bigger Social Security check but could save hundreds or even thousands of dollars a year in taxes. Reichenstein says. If you are in the 10% to 22% federal tax bracket, consider speaking with a tax professional or financial planner about how to mitigate your potential tax burden.

Contribute to a Roth

Have at least some money in a Roth IRA o Roth 401(k) can help reduce taxes on Social Security benefits. Withdrawals from these accounts are tax-free in retirement and are not included in your combined income, Sarenski says.

You can’t contribute to a retirement account if you have no income, so people should diversify their retirement accounts long before they stop working, he says. Putting all your money into a pre-tax option could mean facing a huge tax bill later.

“People should try to balance what they have in pre-tax and after-tax income so they can balance their taxes in the future when they retire,” Sarenski says.

Be charitable with your IRA

Once you are 70½, you can make qualified charitable distributions, which are gifts from your IRA to a charity. The withdrawal is not taxable and will not count in your combined income as long as the money is transferred directly from the IRA custodian to the charity. You can transfer up to $100,000 this way.

If you have reached the age at which required minimum distributions of retirement accounts must begin (currently, that age is 73); Qualified charitable distributions can count as your RMD, Sarenski says.

Consider other ways to reduce distributions.

If you’ve been a good saver, RMDs can push you into a higher tax bracket, as well as trigger higher taxes for Social Security, Sarenski says.

Tapping into your retirement funds before you’re forced to do so could make sense, as would a Roth Conversionsays Sarenski. With a conversion, money is transferred to a Roth IRA from a pre-tax retirement account, such as an IRA or 401(k). Conversions generally incur taxes, but withdrawals in retirement are tax-free.

Again, consider speaking to a tax professional or financial planner first. Taking too much out of retirement accounts can result in unnecessary taxes, increase Medicare or Affordable Care Act premiums, and have other financial repercussions, such as running out of money prematurely. Avoiding those pitfalls requires careful planning, Sarenski says.

“For me, the idea is to soften tax rates,” Sarenski says. “You don’t want years where you pay 40% and years where you pay zero.”

This article was written by NerdWallet and originally published by The Associated Press.

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Liz Weston, CFP® writes for NerdWallet. Email: lweston@nerdwallet.com. Twitter: @lizweston.

Article Three ways to reduce social security taxes originally appeared on NerdWallet.

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