Social Security Strategies
A majority of people receiving Social Security benefits pay income tax on some of those earnings. That's because, as of 1983, Social Security payments have been subject to taxation above certain income thresholds. With no inflation adjustment having been made to these benchmarks since 1983, they're now exceeded by most taxpayers who receive Social Security benefits and have other sources of income, too.
A number of strategies, both before and after you retire, can limit the amount of tax you pay on Social Security benefits. These include carefully planning when—and in what order—you withdraw money from tax-sheltered retirement accounts. Reducing your taxable income during the years in which you're drawing Social Security can have other benefits, too, such as lowering your Medicare premiums, which vary by income.
- Up to 50% of Social Security benefits are taxable for individuals with a combined income of at least $25,000, or a couple filing jointly with a combined income of at least $32,000.
- Up to 85% of Social Security benefits are taxable for individuals with a combined income of at least $34,000, or a couple filing jointly with a combined income of at least $44,000.
- Retirees who receive very little other income, either from retirement plan payouts or other earnings, probably won't pay taxes on their Social Security benefits.
How Much of Your Social Security Income Is Taxable
No taxpayer, regardless of income, has all of their Social Security benefits taxed. Here's how the IRS calculates how much is taxable.
The calculation begins with your adjusted gross income from sources other than Social Security. That income may include wages, self-employed earnings, interest, dividends, required minimum distributions from qualified retirement accounts, and other taxable income that must be reported on your tax returns. Then any tax-exempt interest is added. Finally, (only) half of your Social Security benefits are added to those other earnings to arrive at the combined-income figure that will determine how much of your benefits is taxable.
A schedule of rates is then applied to that income figure to arrive at the tax, if any, you have to pay. The rate that applies to you depends on your filing status and income.
Individual Tax Rates
Benefits will be subject to tax if you file a federal tax return as an "individual" and your combined income from all sources is as follows:
- Between $25,000 and $34,000: You may have to pay income tax on up to 50% of your benefits.
- More than $34,000: Up to 85% of your benefits may be taxable.
Married Tax Rates
For couples who file a joint return, your benefits will be taxable if you and your spouse have a combined income that is as follows:
- Between $32,000 and $44,000: You may have to pay income tax on up to 50% of your benefits.
- More than $44,000: Up to 85% of your benefits may be taxable.
If you're married and file a separate tax return, taxes on your benefits will be figured at the rates listed above for individuals.
Paying Tax on Social Security
You will receive a Social Security Benefit Statement (Form SSA-1099) each January, detailing the amount in benefits you received during the previous tax year. You can use this to determine whether you owe federal income tax on your benefits. If you do owe taxes on your Social Security benefits, you can make quarterly estimated tax payments to the IRS or choose to have federal taxes withheld from your payouts before you receive them.
Possible State Tax on Social Security
There are 13 states in which your Social Security benefits may also be taxable at the state level, at least to some beneficiaries. If you live in one of those states—Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia—check with the relevant state tax agency. As with the federal tax, how these agencies tax Social Security varies by income and other criteria.
Can I Work While Collecting Social Security?
When Social Security Is Not Taxable
It's unlikely you'll be assessed for tax on Social Security benefits if you have little to no supplemental income from retirement plan distributions or other earnings. The average benefit paid out as of Nov. 2019 was about $1,359 per month, or $16,308 annually. As the schedule above shows, benefits are only taxable when overall income exceeds $25,000 for single retirees or $32,000 for couples filing joint tax returns.
The average monthly Social Security benefit as of Nov. 2019; the annual total is $16,308.
Avoiding Tax on Benefits
The simplest way to keep your Social Security benefits free from income tax is to keep your total combined income so low it falls beneath the thresholds to pay tax. However, most retirees are not able to live on the fairly meager average monthly benefit without supplementing it from investments or other sources.
For most people, then, a realistic goal is to limit how much tax is paid on Social Security benefits. This can be accomplished through a number of creative solutions around the retirement accounts in which you place your savings, and the order in which you tap those assets for income. Here's a rundown of some such solutions:
Receive Taxable Income Before Retirement
One promising means to minimize your taxable income when drawing Social Security is to maximize, or at least increase, your taxable income in the years before you begin to receive benefits.
A leading way is to withdraw funds early—or "make distributions," in the retirement parlance—from your tax-sheltered retirement accounts, such as IRAs and 401(k)s. Keep in mind that you can make distributions penalty-free after age 59½. That means you avoid being dinged for making these withdrawals too early, but you must still pay tax on the amount you withdraw.
Since any withdrawals are taxable, they must of course be planned carefully with the other taxes you will have to pay on income for the year. The goal is to pay less in tax by making more withdrawals during this pre-Social Security period than you would after you begin to draw benefits. That requires considering the total tax bite from withdrawals, Social Security benefits, and any other sources.
Be mindful, too, that at age 72, you're required to take minimum distributions from these accounts, so you need to plan the funds for those mandatory withdrawals. The age for required minimum distributions was raised from 70½ to 72 by the SECURE Act of 2019.
This strategy can help you do more than optimize the tax treatment of taking money from these accounts. By providing early income for retirement, it can also allow you to delay beginning to receive Social Security benefits. And that increases the size of the payments.
Keep Some Retirement Income in Roth accounts
The contributions made to a Roth IRA or 401(k) are in after-tax dollars, which means they're not subject to tax when the funds are withdrawn. Instead of taking taxable distributions from a traditional IRA or other qualified retirement plans, taking distributions from a Roth IRA can provide supplemental income without affecting the combined income calculation. That, in turn, means they won't increase any tax you're liable to pay on your Social Security benefits.
That advantage makes it wise, well before retirement, to consider a mix of regular and Roth retirement accounts. Such a blend will allow you greater flexibility to manage the withdrawals from each account to minimize the taxes you will owe on your Social Security benefits. A similar effect can be achieved by withdrawing from conventional savings or money market accounts in lieu of tax-sheltered ones.
Buy an Annuity Contract
A Qualified Longevity Annuity Contract (QLAC) is a deferred annuity funded with an investment from a qualified retirement plan or IRA. QLACs provide guaranteed monthly payments until death and are shielded from the downturns of the stock market. As long as the annuity complies with Internal Revenue Service (IRS) requirements, it is exempt from the required minimum distribution rules until payouts begin after the specified annuity starting date.
By limiting distributions, and thus taxable income, during retirement QLACs can help minimize the tax bite taken from your Social Security benefits. Under current rules, an individual can spend 25% or $135,000 (whichever is less) of their retirement savings account or IRA to buy a QLAC via a single premium. The longer an individual lives, the longer a QLAC pays out.
QLAC income may be deferred until age 85. QLACs allow a spouse or someone else to be a joint annuitant, meaning that both named individuals are covered regardless of how long they live (with some conditions).
Despite the appeal of QLACs in limiting taxable income, they shouldn't be bought merely to help minimize taxes on Social Security benefits, or even in general. Retirement annuities have both advantages and disadvantages that should be weighed carefully, preferably with help from a retirement advisor, before you choose this vehicle to help provide income after your working life ends.