We all plan our best retirement funding strategy for income and withdrawal rate. But just as important for U.S. retirees is giving thought to Social Security Tax Strategies. This is so we can keep more of our Social Security benefit.
We are not talking about a lot of retirement income pushing our Social Security into the taxable category. It gets easier to cross the retirement taxable income thresholds as time goes. That is because the thresholds are not adjusted for inflation or any changes in average wages. Thus making it negatively impact more of the middle class over time.
I am fully OK with paying taxes on my IRA withdrawal as income. That’s because I took a tax deduction when I made the contributions into my IRA and 401K as a working stiff. However it pains me to have to pay taxes on any of my received Social Security. Especially when it’s due to enjoying a retirement paid for and funded by my years of financial responsibility. My smart frugal living and simple non-wasteful/non-consumerist lifestyle.
On top of that, we have already paid taxes on the amount we paid into Social Security. Paid at our income rate as it is deducted from our pay checks. Our Social Security contribution is paid after taxes. Double taxation seems unfair but that is what we have. So having good Social Security Tax Strategies to pay a minimum tax payment, saving us 5%, 10%, or more to use for ourselves is a smart move.
Social Security Tax Strategies – How Your Social Security Becomes Taxable
The way the Social Security Administration (SSA) explains it. It is only people with “other substantial income” that have to pay federal incomes taxes on their Social Security.
Sorry, but we are not talking about substantial income now. 10 years from now income thresholds will be hit much easier.
Retirement Income counted in this “other substantial income” includes any wages, self-employment income, interest, dividends and other taxable income that we have to report on our tax return. This includes withdrawals from our IRA or 401K. It isn’t just these sources of income that is used against the taxable earnings threshold amounts. You must also add in 50% of your received Social Security.
This is how your adjusted gross income is used for the purpose of taxing your Social Security
Your adjusted gross income. (i.e. wages, self-employment income, interest, dividends, IRA/401K withdrawals, taxable pension/annuity, etc.)
+ Plus Non-taxable interest. (excluded from taxes on your federal return but considered as part of the taxable Social Security threshold calculation)
+ Plus ½ of your Social Security benefits. (individual, or joint-you and your spouse combined)
= Equals Your combined income. (used against the taxable Social Security thresholds)
The Social Security Earnings Thresholds are:
If you file a federal tax return as an “individual” and your –
- Combined income is between $25,000 and $34,000. You may have to pay income tax on up to 50 percent of your benefits.
- Combined income is more than $34,000. Then up to 85 percent of your benefits may be taxable.
If you file a joint return, and you and your spouse have –
- A combined income that is between $32,000 and $44,000. You may have to pay income tax on up to 50 percent of your benefits.
- A combined income that is more than $44,000. Then up to 85 percent of your benefits may be taxable.
If you are married and file a separate tax return –
You most likely will pay taxes on your benefits.
Important Note– Did you notice that Roth IRA withdrawals are not listed as included in the earnings threshold calculation?
Social Security Tax Strategies to cut your taxes.
If you are someone who is only living on Social Security with no other income or very little extra income. Then you have no tax implications to worry about. If you have Social Security and a taxable Pension. Then your monthly income is fixed. You may have to pay taxes depending where your combined Pension and 50% of your Social Security lands in the Social Security income thresholds .
For those who have a sizable tax deferred (IRA/401K) portfolio that they are using to fund retirement instead of a pension. Then there are a few things to consider doing to lower our taxes once we start taking Social Security. However nothing is easy or clear-cut with taxes. So everyone’s unique situation requires some careful analysis. That said it seems any Social Security Tax Strategies will rely on three key actions.
Pre- Social Security Retirement Account draw-down
This seems to be the first key to consider. At issue is drawing from your tax advantaged retirement portfolio and living off of that while paying regular income taxes before starting your Social Security.
We all have to start taking money from the portfolio at age 70 ½ anyway. That is to meet the Required Minimum Distribution (RMD) requirements. The bigger the portfolio the higher the RMD amount we have to take out and pay taxes on.
By reducing the IRA portfolio we reduce the RMD withdrawal. Hopefully also reducing any taxable implications for our Social Security once we start taking it. This leads to the second key.
Delay Starting Your Social Security
We can begin taking Social Security at age 62 and forever lock into a reduced payment. We can wait until our full retirement age around age 67. We can delay starting payments up to age 70. Where we will get an 8% increase for every 12 month period we delay beyond your full retirement date.
While drawing down our IRA assets before taking Social Security our delayed Social Security payments will increase. Delaying Social Security until age 70 with a higher benefit means the 50% of Social Security portion of the Social Security income threshold calculation will also be higher.
This will trigger Social Security taxes in most cases once RMD is taken if there is still a sizable IRA portfolio. This is a perfect time to bring up the third key action.
Pre-Social Security Roth conversions
I believe this third key action is the one that makes the Social Security Tax Strategies work. If you have a large IRA portfolio then converting some to a Roth before starting your Social Security gives the ability to withdraw up to the Social Security income thresholds from our IRA and then supplement anything else in our budget with Roth withdrawals.
With the Roth there are no Social Security tax implications. However we don’t want to just convert a large chunk of our IRA to a Roth because that triggers income taxes in the year we do it. We need to keep our income down to the lower tax brackets/rates.
There is no sense pushing our pre-Social Security income into a higher tax rate to save taxes on part of our Social Security later. If we can keep our income no more than the 15% tax bracket then it is worth looking at making the Roth conversations in strategic chunks during the years before starting our Social Security and paying taxes then.
Move IRA Money to a QLAC- Qualified Longevity Annuity Contract
If you haven’t heard about the Qualified Longevity Annuity Contract (QLAC) before you are not alone. It was only created by the U.S. Treasury Department in 2014 as a simple low cost longevity annuity.
The thing that makes this annuity relevant to Social Security Tax Strategies is that a QLAC, unlike other annuities held within your IRA, can be delayed from RMD rules up to age 85.
There are limitations in the amount you can move into a QLAC but it may be beneficial to consider including in your Social Security Tax Strategies and overall retirement funding. I have a page with details about the QLAC that you may want to read.
If paying taxes on your Social Security is a given then you can choose to have the SSA withhold taxes from your Social Security checks. This may save you from possibly having to pay estimated taxes through the year.
Request and fill out the federal tax withholding form W-4V. You can chose to withhold 7, 10, 15 or 25 percent of your Social Security check for federal taxes. Call Social Security at 800-772-1213 and ask for IRS Form W-4V or use their online form request portal.
Be aware that depending which State you live in there may also be State taxes that need to be paid for your Social Security. Tax and accounting firm Wolters Kluwer found for year 2014 that there were 14 states that tax Social Security payments for some retirees.
These 14 States are: Colorado, Connecticut, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, New Jersey, North Dakota, Rhode Island, Vermont and West Virginia.
Any Social Security Tax Strategies will have to rely on delaying the start of taking Social Security and having a Roth IRA portfolio to use to avoid crossing the Social Security taxable income thresholds.
When considering pre-Social Security Roth conversions pay attention to the tax brackets. Example, for those Married filing jointly the 15% tax bracket for 2014 was income from $18,151 to $73,800.
If withdrawing from your IRA $40,000 to fund your retirement then keep Roth conversions below the top end of the 15% tax bracket. I.e. $40,000 – Standard Deduction/Personal exemptions of $20,300 = $19,700 taxable. The top of the 15% income tax bracket $73,800 – $19,700 = $54,100. Convert to Roth any amount up to $54,100 to stay in the 15% tax bracket.
Convert to Roth as much as you feel comfortable paying taxes on each year to fund your later retirement with your Social Security tax-free.
Be cognizant that once RMD starts at age 70 ½ you will be forced to withdrawal a predetermined percentage of your IRA portfolio each year that may cross the Social Security income thresholds. Once we reach the age of 70 1/2 and begin RMD we will lose options for Social Security Tax Strategies.
Everyone’s portfolio and Social Security Tax Strategies may be different. Find the way that works best for you.