Social Security Taxes: 3 Ideas to Help Minimize the Impact

Many retirees are surprised to learn that, above a certain income threshold, Social Security can be subject to taxation. Here are strategies to consider.

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Key Takeaways

  • Converting a traditional retirement account to a Roth may help reduce taxes on Social Security income
  • Revisit your sources of retirement income, as dividends and interest payments can increase your Social Security taxes
  • Consider delaying your Social Security benefits to reduce the taxes you may have to pay 

For many retirees, Social Security benefits are a crucial component of their retirement income strategy. However, many Americans are surprised to learn that some of that income can be taxed. If you’re currently receiving Social Security benefits or plan to start soon, make sure you understand how Social Security could be taxed.

When Social Security Benefits Are Taxed 

Generally, your Social Security is taxed when your income is more than $25,000 per year, including income from investments held in retirement accounts such as traditional 401(k)s and IRAs. If Social Security is your only source of income, you likely won’t pay any taxes on it. However, if you’re receiving income from investments, a part-time job, or other sources, there’s a good chance you’ll have to pay taxes on your Social Security income.

Regardless of your total income, the maximum taxable portion of your Social Security benefits will not exceed 85% under the current tax codes.

If your benefits are indeed subject to taxation, you can consider three key strategies to potentially reduce the tax implications:

  1. Converting a traditional 401(k)/IRA to a Roth 401(k)/IRA account
  2. Delaying Social Security benefits
  3. Leveraging investments that provide nontaxable income

Let’s look at how to determine if your Social Security income will be taxed, plus a few ideas to help reduce your taxable income in retirement. 

How Social Security Taxes Are Calculated

To calculate your taxable Social Security benefit, first determine your adjusted gross income (AGI), which is your total taxable income. This might include money you make from:

Social Security Tax: Will It Affect You?
For illustrative purposes only. 
  • Employment
  • Distributions from traditional 401(k) plans and traditional IRAs
  • Taxable income from investments, such as stock dividends and interest from taxable accounts

Next, subtract any tax deductions. The result is your AGI. Then, add two components to that AGI:

  • Your nontaxable interest
  • Half the amount of your Social Security benefit 

This total is your “combined income.” If your combined income is more than $34,000 for singles or $44,000 for couples, up to 85% of your Social Security income may be taxed

3 Ideas to Help Reduce Your Taxable Income in Retirement

Social Security income is taxed at a lower rate than income from other sources, such as traditional retirement accounts. So you may want to consider the following strategies to help reduce your income from those retirement accounts so a greater portion of your income is derived from Social Security.

  1. Convert to a Roth IRA.Withdrawals on Roth IRAs and Roth 401(k)s are not subject to taxation. That’s because taxes were taken when the contributions were made. If your money is in a traditional IRA or 401(k), you already received a tax advantage in the form of an income tax deduction when you deposited the money, so 100% of those withdrawals will be taxed as income. Income from a Roth account does not count toward the “combined income” that will affect taxes on your Social Security benefits. But remember, you must have a Roth account open for five years before you can withdraw the money tax-free. You can open a Roth at any time. Plus, you can continue to contribute to a Roth in retirement if you have earned income. (Income must be from employment or self-employment wages. Income from investments or Social Security don't qualify as income for the purposes of contributing to an IRA.)

    Be aware that converting from a traditional retirement account to a Roth IRA means you’ll pay income tax on the amount in the account, but after that first tax bill, distributions will be tax free and won’t be counted toward your income calculation. Also, due to a provision in the 2017 Tax Cut and Jobs Act, as of 2018, a Roth conversion can no longer be “recharacterized,” which means it can’t be transferred back to a traditional IRA if you change your mind about the conversion.
  2. Consider shifting income investments.Some investments generate taxable income, while others are nontaxable. For example, the interest income from many bonds is subject to tax. Dividends and interest from savings accounts or other investments also count as taxable income. Interest income on municipal bonds is typically exempt from federal and state income taxes, however any capital gains distributed may be taxable to the investor. Also, income received from muni investments for some investors may be subject to the Alternative Minimum Tax (AMT).

    With a strategy of reallocating investments to include nontaxable income, investors can accept retirement payments that do not count as income, which means they won’t add to the income that can trigger taxes on Social Security benefits. By shifting your assets to those that favor the types of income that are shielded from taxation, you can still plan for the same amount of retirement income with potentially lower taxes on your Social Security.
  3. Delay claiming your Social Security benefits.If you have outside income and other investments, you might be better off being more aggressive on drawing down those assets early on, while delaying taking Social Security. You’ll get a Social Security bump the longer you wait—8% per year until age 70By then, if you’ve drawn down other assets (which are likely taxed at a higher rate), there might be fewer of those assets left to tax, which can potentially lower the amount of your Social Security benefits subject to taxation.

    Before choosing to delay your Social Security benefits, assess your expected income from all sources and compare them to your expected expenses. This can help ensure that you’ll have the funds to live comfortably.    

The Bottom Line

Social Security taxes may come as a surprise to many retirees, but there are several effective ways to reduce these taxes. Examine how all your income sources might impact your tax rate, and then consider your available strategies for getting the most out of your retirement income.

TD Ameritrade does not provide tax advice. You should consult with a tax professional regarding your specific circumstances.

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Key Takeaways

  • Converting a traditional retirement account to a Roth may help reduce taxes on Social Security income
  • Revisit your sources of retirement income, as dividends and interest payments can increase your Social Security taxes
  • Consider delaying your Social Security benefits to reduce the taxes you may have to pay 

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