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7 Ways to Reduce Taxes on Social Security Benefits

Moves that lower taxable income can also limit the IRS bite on your benefits

For many older Americans, Social Security payments are a financial lifeline. They may also be taxable income, which can come as an unpleasant surprise to new beneficiaries unaware that the IRS can take a bite out of their benefits. 

That doesn’t apply to all Social Security recipients. If your overall income is below certain thresholds, you pay zero taxes on your benefits. Unfortunately, those thresholds are pretty low. 

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Under federal law, Social Security benefits are taxable if your “combined income” — adjusted gross income (AGI) plus nontaxable interest plus half of your benefits — is at least $25,000 for an individual taxpayer and $32,000 for a married couple filing jointly. 

Below that level, benefits aren’t taxed. (Most people with income only from Social Security are in this category.) If your combined income is $25,000 to $34,000 (single) or $32,000 to $44,000 (couple), up to 50 percent of what you get from Social Security is taxable. Above $34,000 for single filers and $44,000 for couples, up to 85 percent of benefits are taxable.

Those rules mean retirees have options to reduce or eliminate the tax burden on their benefits. In a nutshell: “It’s about reducing your income,” says Tim Steffen, director of advanced planning for wealth management firm Baird. 

Reducing income isn’t always the best thing for your financial health, and if what you’re bringing in is well above the IRS income thresholds, there’s really not much you can do to avoid paying tax on your benefits.

But if your income is close to one of the taxability thresholds, lowering your AGI via investment moves, tax-friendly retirement account distributions or other means could shield more of your benefits (or future benefits) from the IRS. Here are some of the options.

1. Prioritize withdrawals from tax-free retirement accounts.

If it’s an option, take distributions from a Roth 401(k) or Roth IRA rather than a traditional retirement account

The beauty of a Roth is that withdrawals are tax-free, as long as the account has been open for at least five years. That means any distributions you take are “not going to count as taxable income when it comes to the Social Security calculation,” says Nicole Birkett-Brunkhorst, a wealth planner at U.S. Bank and a registered Social Security analyst.

If your income derives solely from Social Security and a tax-free Roth account, you have a good chance of keeping the taxable portion of your benefits close to zero, according to Noah Harden, regional wealth planning manager at Comerica Bank. 

If you’ve considered converting a traditional IRA to a Roth IRA to gain such tax advantages, now might be a good time, Steffen says. While the bear market lowers stock prices and IRA account balances, the tax hit from a Roth conversion will be less than when stocks sold at higher prices. 

2. Donate your RMDs to charity. 

If you’re at an age where you must take required minimum distributions (RMDs) from your retirement accounts, you can avoid having the proceeds count as taxable income by donating the money to charity by Dec. 31 of each tax year. 

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“This is a good strategy for somebody who is forced to take money out of an IRA that they don’t need,” Steffen says. Just remember that the RMD donation from a traditional IRA or 401(k) must be transferred directly from your account to the charity. 

3. Take IRA or 401(k) withdrawals before claiming Social Security. 

The advantages of this approach are twofold. First, taking distributions from tax-deferred retirement accounts will reduce your balance, thus reducing the size of your future RMDs (which are determined, in part, by how much is in the account) and, by extension, your future AGI.

Second, generating income from your retirement accounts early enables you to defer taking Social Security, which results in bigger benefits. Your monthly benefit amount increases by 5 percent to 8 percent for each year past the minimum age of 62 that you delay claiming it.

4. Make tax-deductible contributions to retirement accounts. 

Depending on your income and whether you have a job-based retirement plan such as a 401(k), contributions to an IRA can be fully or partially tax-deductible and thus lower your AGI.

The IRS annually sets limits on deductible IRA contributions. It’s not too late to max out for the 2022 tax year: Earners over age 50 can stash up to $7,000 in pretax dollars in an IRA by April 18. For the 2023 tax year, the contribution limit rises to $7,500. 

Contributions to a health savings account (HSA) may also be tax-deductible and reduce your taxable income, Harden notes.

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5. Defer gig-work income. 

If you earn extra dollars driving for Uber, walking dogs for Rover.com or doing freelance consulting work, you can lower your taxable income in a few different ways, says Mark Steber, senior vice president and chief tax information officer at Jackson Hewitt Tax Service. 

For example, you could:

  • Defer income into another year by sending out invoices after Dec. 31. 
  • Pull business expenses you planned for next year — say, a new printer for the home office or a professional development course — into the current year to take the tax deduction sooner.
  • Contribute pretax dollars to an eligible retirement account, such as a traditional IRA, Solo 401(k) or SEP (simplified employee pension) IRA. 

Or you could simply opt to work a little less, if you’re getting close to one of the income thresholds and the tax savings from not crossing it would make up for the lost income.

6. Offset investment gains with losses. 

Taxable stock portfolios took a hit in the bear market. If you sell some depressed stocks, you can use those losses to offset income earned on capital gains and potentially write off up to $3,000 in ordinary income. This strategy, dubbed tax-loss harvesting, is a way to “realize a loss and take it as a tax deduction,” Birkett-Brunkhorst says.

7. Pivot to a tax-efficient investment portfolio. 

Loading up taxable investment accounts with assets that generate lots of income, such as real estate investment trusts, dividend-paying stocks or most types of bonds, can increase the tax hit on your Social Security benefits. An alternative strategy might be putting income-generating investments into tax-deferred accounts such as IRAs and 401(k)s. 

You’ll want to fill your taxable accounts with growth stocks. These only generate capital gains when they are sold, and those gains are taxed at a more favorable rate than ordinary income: 0 percent for people with taxable income below $44,625 and 15 percent for income of $44,625 to $492,300 in the 2023 tax year.

“If you have investments that have advantageous capital gains treatment or potentially lower dividends, that’s going to be something that will lower your AGI and lower the taxable amount of your Social Security,” Harden says.

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