3 Ways You Can Beat the Social Security ‘Stealth Tax’

Senior man using a calculator while reviewing his budget
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Although some of your Social Security benefits will always be tax-free, as much as 85% may become taxable, depending on your income. While benefits increase every year thanks to the annual cost-of-living adjustment, the income limits for determining taxability of benefits do not.

As a result, more and more Social Security recipients have found themselves in the position of paying tax on their benefits. Many advisors refer to this as a “stealth tax,” as it quietly taxes more and more beneficiaries every year without much attention being drawn to it. While you can’t change governmental policy regarding these income limits, there are some steps you can take to minimize its effect. Here’s a look at how.

What Are the Income Limits for Social Security Taxation?

Before you can take steps to minimize the taxation of your Social Security, you’ll have to know what the income limits are. Here are the limits for individuals:

  • 50% tax: combined income between $25,000 and $34,000
  • 85% tax: combined income exceeding $34,000

And here are the limits for joint filers:

  • 50% tax: combined income of $32,000 to $44,000
  • 85% tax: combined income exceeding $44,000

For the purposes of Social Security taxation, “combined income” refers to your adjusted gross income plus your nontaxable interest plus 50% of your Social Security benefits.

Convert Your 401(k) and/or Traditional IRA to a Roth IRA

The only real way to get around paying taxes on your Social Security income is to lower your income below the SSA thresholds. Of course, lowering or eliminating your income means you have less money to live on, so it’s always better to earn more money and pay the taxes rather than have less money overall by avoiding taxes. However, if you can generate income and still fall under the taxation thresholds, that’s the perfect scenario.

Are You Retirement Ready?

Many retirees rely to some degree on their retirement accounts to fund their golden years, typically in the form of 401(k) and/or IRA income. But as the money you withdraw from these accounts is taxable, it could push you above the Social Security taxation limits. To avoid this, you’ll want to turn as much of your taxable retirement income as possible into tax-free income.

The best way to accomplish this is to convert your taxable retirement accounts into a Roth IRA. Although you’ll have to pay tax at the time of conversion, you’ll be able to withdraw that money tax-free in retirement. As those distributions won’t appear in your adjusted gross income, you may be able to remain under one or both of the Social Security taxation limits.

Defer Filing for Social Security

Another way to avoid taxation of your Social Security benefits is to defer them as long as possible. By waiting to file for your benefits, you’ll also increase them. By waiting until age 70 to file for benefits instead of age 67, your benefits will permanently increase by 24%. Although you’ll have to deal with the taxation of your benefits then, you’ll defer the problem by three years in this scenario.

If you wait to file for your Social Security benefits, of course, you’ll need to live off other income. But if you have money in your retirement accounts, you can actually benefit by drawing down the balances while waiting for your Social Security to kick in, meaning you won’t be drawing as much taxable income once you do file for your benefits. Remember, only 50% of your Social Security benefits are considered for the “combined income” calculation, vs. 100% of the money you withdraw from taxable retirement accounts.

Are You Retirement Ready?

Stagger Your Income, If Possible

In some cases, you may be able to push income from one year into another. If you are working a part-time job and you are getting a year-end bonus, for example, you may be able to push that payment date into January of the following year in order to avoid it qualifying as taxable income in the current year. Not all employers are willing to do this, but it’s worth it to try.

The same is true if you are self-employed and have some outstanding invoices. Pushing their actual receipt into the following year can help reduce your income for the current year, potentially helping you avoid the taxation of your Social Security benefits.

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