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8 Tips For Avoiding Taxes on Social Security Benefits

MULTIZ321

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8 Tips For Avoiding Taxes on Social Security Benefits
By Paul Katzeff/ Retirement/ Investor's Business Daily/ investors.com

"Social Security benefits are taxable but only up to certain limits. And there are steps you can take to avoid or cut how much of your Social Security benefits you've got to fork over to the tax man.

Taxes kick in on your Social Security benefits if your income exceeds certain limits. As a rule of thumb, if Social Security provides your only income in retirement, you probably won't have to pay taxes on your monthly benefit. But if you have additional income, such as wages or withdrawals from an IRA, then your benefit will likely be taxed.

Some people hate the idea of paying taxes on Social Security benefits so much that they're willing to sacrifice income for the satisfaction of not having to pay tax on their bennies.

Of course, you should resort to those strategies only if you don't need the extra income to live on.

"Make sure the tail is not wagging the dog," said Colleen Carcone, a director of wealth planning strategies for financial services giant TIAA, addressing only tax-minimizing strategies. "Make sure investment decisions are based on overall planning objectives, not solely based on tax consequences."

If you can afford to go without the income, these eight steps will keep your income below the tax-triggering thresholds, or at least minimize the taxes that you pay....."

Richard
 

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I had a chance to read up on SS recently and one issue came across is in determining how much SS is taxed. Specifically, the provisional income exemption 'threshold' (unsure of the proper term for this) has not been adjusted for any cost-of-living factor since the SS taxation rules were introduced in the 1980's. In other words, couples filing jointly had a $32,000 allowance on provisional income since day one. If adjusted for inflation, this exemption would be over $50,000 today (as far as I can recall), but it has never changed. Maybe a change to this exemption level is in order?

Here are some resources I have come across.

https://www.investopedia.com/terms/p/provisional-income.asp

https://www.govinfo.gov/content/pkg...e26-subtitleA-chap1-subchapB-partII-sec86.pdf

https://www.aarp.org/content/dam/aarp/work/social_security/2011-10/Social-Security-and-Taxes.pdf
 
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Ralph Sir Edward

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Converting to Roths over time is the main answer.

This get trickier, (you have to compare tax rates), but you may be better off pulling out more than one year's worth of Traditional IRA money to get you over the "camel's hump" of SS taxation. (Sort of like paying two years of property taxes in the same year.)

Like all taxes, this is a complex game. Break out your green eye shades . . .

(If you have a lot in pensions, hang it up - there is no way around the SS tax trap.)
 

Conan

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The tax on SS income is the most irksome. Okay, tax me on IRA withdrawals--I took an income tax deduction when I made my contributions and my IRA investment gains were tax-free up to now, so fair is fair.

But those SS taxes my employer and I paid during my working years--my employer deducted their share, but my share was paid from after-tax money.

Example: My employer budgets $120,000 for my salary and Social Security/Medicare ("FICA") tax costs. My W-2 at year end reports $111,472 of taxable income, since they paid $8,528 of FICA tax at the 7.65% rate. But that $8,528 is only the employer's half of the FICA tax. My after-tax (take-home) pay (assume I'm in a 24% federal tax bracket and ignore state income tax) is $111,472 - $26,753 income tax - $8,528 additional FICA tax = $76,191 net to me.

When I retire and start collecting, maybe tax 50% of my SS income to recoup the deduction my employer took. But why should SS be up to 85% taxable?
 
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winger

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Here are a couple of writings I just found.

https://www.ssa.gov/history/taxationofbenefits.html

https://www.fool.com/retirement/2017/12/27/you-can-legally-avoid-taxes-on-your-social-securit.aspx

This thread actually reminded me I wrote down a to-do to write my Washington DC representatives to address the cost-of-living 'oversight' (unsure how else to describe it) I mentioned above. Implementing a COLA on the SS taxation would be a nice direction back towards not taxing SS at all, at least by federal taxes. On the state level, it was interesting to find out some states do not tax SS, yet another twist.
 
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VacationForever

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The tax on SS income is the most irksome. Okay, tax me on IRA withdrawals--I took an income tax deduction when I made my contributions and my IRA investment gains were tax-free up to now, so fair is fair.

But those SS taxes my employer and I paid during my working years--my employer deducted their share, but my share was paid from after-tax money.

Example: My employer budgets $120,000 for my salary and Social Security/Medicare ("FICA") tax costs. My W-2 at year end reports $111,472 of taxable income, since they paid $8,528 of FICA tax at the 7.65% rate. But that $8,528 is only the employer's half of the FICA tax. My after-tax (take-home) pay (assume I'm in a 24% federal tax bracket and ignore state income tax) is $111,472 - $26,753 income tax - $8,528 additional FICA tax = $76,191 net to me.

When I retire and start collecting, maybe tax 50% of my SS income to recoup the deduction my employer took. But why should SS be up to 85% taxable?
Employee FICA that is taken out is pre-tax, not post-tax.
 

winger

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Converting to Roths over time is the main answer.

This get trickier, (you have to compare tax rates), but you may be better off pulling out more than one year's worth of Traditional IRA money to get you over the "camel's hump" of SS taxation. (Sort of like paying two years of property taxes in the same year.)

Like all taxes, this is a complex game. Break out your green eye shades . . .

... .
Talk about complex, the more I have read recently about SS and taxes, the more it just seems there are simply too many unknowns to formulate a 'perfect plan'. For example, SS earnings and Required Mandatory Distribution (RMD) combined (and pensions, if applicable) can really result in huge tax bills as couple gets deeper into the 'Golden Years'. Throw in the passing of a spouse resulting and the resulting lowering of tax exemption thresholds, you can literally see the lowering of income (e.g. loss of spousal SS, pension, etc.), yet see an increase of income taxes and also possibly Medicare monthly premiums increaes (parts B and D?), too!
 

VacationForever

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Talk about complex, the more I have read recently about SS and taxes, the more it just seems there are simply too many unknowns to formulate a 'perfect plan'. For example, SS earnings and Required Mandatory Distribution (RMD) combined (and pensions, if applicable) can really result in huge tax bills as couple gets deeper into the 'Golden Years'. Throw in the passing of a spouse resulting and the resulting lowering of tax exemption thresholds, you can literally see the lowering of income (e.g. loss of spousal SS, pension, etc.), yet see an increase of income taxes and also possibly Medicare monthly premiums increaes (parts B and D?), too!
This is indeed the dilemma that we are facing. We have been pondering as to whether to buy a QLAC. If we do, it will bump up our tax rate and result in higher Medicare IRMAA rate, and also hugely impact the surviving spouse's tax obligations.
 

winger

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This is indeed the dilemma that we are facing. We have been pondering as to whether to buy a QLAC. If we do, it will bump up our tax rate and result in higher Medicare IRMAA rate, and also hugely impact the surviving spouse's tax obligations.
Oh, thanks for yet another layer to read up on LOL


https://www.fool.com/retirement/general/2015/12/28/what-is-a-qlac-and-why-might-you-want-one.aspx

I don't understand your point about increasing tax rate if you start a QLAC; I took a quick glance at this article... If you start a QLAC, aren't you attempting to LOWER your tax obligations (and possibly Medicare premiums) ?
 

rapmarks

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This is indeed the dilemma that we are facing. We have been pondering as to whether to buy a QLAC. If we do, it will bump up our tax rate and result in higher Medicare IRMAA rate, and also hugely impact the surviving spouse's tax obligations.
Thanks for the information. This must be what the presenter was referring to at the retirement seminar I attended.
 

Conan

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Employee FICA that is taken out is pre-tax, not post-tax.
I have to disagree.

"For a worker, his entire pay is subject to federal income taxes, including that part that is subject to Social Security payroll taxes, and so, in the sometimes confusing parlance of tax policy, this is said to all be 'after-tax income.'"
https://www.ssa.gov/history/taxationofbenefits.html

In my example you're paying income tax on $111,472, which means you're paying income tax on the part of your earnings that went to pay income tax and FICA tax alike.

Here's someone else's example:
Post-tax deduction example
You pay Jennifer $500 per week. You need to deduct 6% post-tax of each paycheck for her Roth 401(k).

Jennifer does not have any pre-tax deductions, so you do not have to subtract any pay before you withhold taxes.

You need to withhold FICA taxes from Jennifer’s wages. FICA taxes are 7.65% of wages.

Calculate how much FICA tax to withhold.

$500 X 0.0765 = $38.25

Withhold FICA taxes from the total wages.

$500 – $38.25 = $461.75

You also need to withhold federal income tax. Jennifer is a single person and she claimed one Form W-4 allowance. Using Jennifer’s total wages and the wage bracket method for federal income tax withholding, you find that you need to withhold an additional $49 from her paycheck.

$461.75 – $49 = $412.75

Jennifer is not subject to any state or local taxes.

You can now subtract Jennifer’s post-tax deduction for her Roth 401(k). You will calculate the deduction using her gross wages.

You need to withhold 6% for Jennifer’s Roth 401(k).

$500 X 0.06 = $30

Jennifer’s total post-tax deduction for her Roth 401(k) is $30. You will subtract that from her wages.

$412.75 – $30 = $382.75

Jennifer’s total take home pay after taxes and her post-tax deduction is $382.75.
https://www.patriotsoftware.com/payroll/training/blog/a-closer-look-at-after-tax-deductions/
 
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VacationForever

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Oh, thanks for yet another layer to read up on LOL


https://www.fool.com/retirement/general/2015/12/28/what-is-a-qlac-and-why-might-you-want-one.aspx

I don't understand your point about increasing tax rate if you start a QLAC; I took a quick glance at this article... If you start a QLAC, aren't you attempting to LOWER your tax obligations (and possibly Medicare premiums) ?
You only lower it while QLAC payment date has not started. After QLAC payment starts, you will end up with more taxable income than if you were to go with RMD only.
 

VacationForever

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I have to disagree.

"For a worker, his entire pay is subject to federal income taxes, including that part that is subject to Social Security payroll taxes, and so, in the sometimes confusing parlance of tax policy, this is said to all be 'after-tax income.'"
https://www.ssa.gov/history/taxationofbenefits.html

In my example you're paying income tax on $111,472, which means you're paying income tax on the part of your earnings that went to pay income tax and FICA tax alike.

Here's someone else's example:
In your example, 7.65% is calculated from $500, hence it is pre-tax and not post-tax dollars. Tax withholding is then computed after FICA is taken out.
 
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Conan

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Sorry everyone for the back-and-forth. This will be my last reply on this issue.
Yes, in what I called someone else's example, the 7.65% is calculated from $500. It's a matter of definition, but as ssa.gov puts it, "in the sometimes confusing parlance of tax policy, this is said to all be 'after-tax income.'"
"After-tax" and "Post-tax" are the same thing.
 

DavidnRobin

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@Conan - not sure why no more posts? interesting thread...

How about this general scenario for retired folk - which may apply to some here...
(based on Fed Tax Rate steps)

For example (numbers are not exact - off top of head):
Married filing jointly - there is a tax benefit in keeping AGI around $100K. After the new $24K Standard Deduction (and tax rate) - this brings taxable income to a 12% rate at ~$76K.
The Fed tax rate jumps to 22% above this income.

So if one of the spouses takes $20K in Social Security, and the goal is to maximize income compared to tax rate (the $76K step) —

What annual total income should the Joint Filers aim to attain to stay at the 12% rate?
(from sources like pensions, capital gains, interest...)
note: long-term CapGains are not taxed below the $76K threshold (iirc)

What is tax on the $20K of Social Security?



Sent from my iPhone using Tapatalk
 
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Conan

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Hi David

Social Security is entirely tax-free for married joint filers only if their combined income, defined as 1/2 of social security plus all their other income, taxable and tax exempt alike, is less than the $32,000 base amount. So if social security is $20,000 then for it to be entirely tax free there's only room for $22,000 of other income.

Next there's a zone from $32,000 to $44,000 of combined income where social security is taxed at about 50%, and once combined income reaches $44,000 a full 85% of social security income is subject to tax.

Your target is to keep your taxable income below $77,400 (i.e. in the zero to 12% bracket). Adding back the standard deduction of $26,600 (because "elderly" age 65 married joint taxpayers get an extra $1,300 exemption apiece) there's room for AGI of $104,000. The assumed $20,000 of social security takes $17,000 of that so there's still room for $87,000 more. Unless you have that kind of income (not forgetting to include any taxable pension/IRA and required minimum distributions) you'll be OK. The IRMAA penalty tax that drives up Medicare Part B and D premium costs comes in above $170,000 so you're OK there too.

https://www.ssa.gov/planners/taxes.html
https://www.irs.gov/pub/irs-pdf/p915.pdf

P.S. I took you to be referring to social security income at $20,000 but that's on the low side, especially for a married couple since the spouse even with no work history of their own gets a 50% spousal benefit on top of what the spouse with a work history is claiming.
 
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WinniWoman

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This is why I need a financial planner. I just can't handle all this stuff. I hope to have a meeting with a local CPA firm/team with Financial Planning credentials for totally holistic and objective advice. It's all just too overwhelming.

This just hurts my head. When does the retirement fun start is what I want to know?
 

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Motley Fool has a useful calculator that finds the taxable amount of your SS benefit:
https://www.fool.com/retirement/2016/06/06/social-security-tax-calculator-are-your-retirement.aspx#top

Here is my spreadsheet...Motley Fool & I agreed on results.
For Married Filinig Jointly:
1/2 Social Security ..... _______
Other Income ............ _______ (taxed and untaxed)
Combined Income....... ________
Less $32K Exemption... - 32,000
BALANCE TAXABLE...... $_______
Amt in 50% Tier ($32-44K)... ______ (max 12,000)
50% of Amt in This Tier..... _____ (max 6,000)
Amt in 85% Tier (over $44K).. _____
85% of Amt in This Tier..... _____
______________________________
Taxable Amts (Both Tiers)...... ______
or 85% of all SS Inc (if less)... ______

Note: No guarantees, express or implied, as to accuracy.
.
 
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VacationForever

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This is why I need a financial planner. I just can't handle all this stuff. I hope to have a meeting with a local CPA firm/team with Financial Planning credentials for totally holistic and objective advice. It's all just too overwhelming.

This just hurts my head. When does the retirement fun start is what I want to know?
Mary Ann, it is not rocket science. You just need to put everything on a spreadsheet. Use the calculator posted above to figure out how much taxes you will need to pay on Social Security. I am good with cash flow and tax projection. I am a terrible investor and that is the one area I get wealth management services. I have a 20-year, broken down by months, budget spreadsheet for income, expense and tax projection.
 

Talent312

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...I have a 20-year, broken down by months, budget spreadsheet for income, expense and tax projection.

I feel lucky to maintain a 3-month rolling cash-flow budget.
I find CC charges too variable to project much beyond that.
.
 

WinniWoman

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Mary Ann, it is not rocket science. You just need to put everything on a spreadsheet. Use the calculator posted above to figure out how much taxes you will need to pay on Social Security. I am good with cash flow and tax projection. I am a terrible investor and that is the one area I get wealth management services. I have a 20-year, broken down by months, budget spreadsheet for income, expense and tax projection.


Well, I guess I am pretty stupid.

I do keep an excel sheet with our investments, but it is just a running tally of balances, and another for our CURRENT budget. But I am not sure when we will collect SS or how we will draw down our money or really what our expenses will be after we move, if we even can, certainly not 20 years out- that is the part I need help with and need tax advice of how to do it. I don't even know how much my SS will be because I stopped working earlier than planned and now SS has to recalculate it. Will have a better idea with the 2020 statement.

My experience is limited to using TAX ACT to file our income taxes each year. That's about it.

Math was always my worse subject in school.
 

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I was involved with a discussion about tax rates and 401Ks recently. As a example, a couple in NYC are both employed and together fall into the 32% bracket. Not unusual in the city. The effective federal tax rate is less, probably around 23% or so, plus state, City and FICA. The left over pay is probably around 60 - 65% after that. The total effective tax rate (Federal plus state plus City plus FICA) is around 35 - 40%

Lets say you saved a decent amount in your 401k -- $2MM. Which is very possible if both spouses contribute the max during 30 years.

So a 4% minimum withdrawl is $80K. Plus 2 people getting the max SS payment of around $4K per month (Future estimate) will bring that total to $176K. Since you pay tax on 85% of SS, your taxable income is $161K, less the $24K standard deduction which comes to $137K. You pay only 12% on the first $77K and 22% on the balance. That comes out to $22K of tax. An effective rate of 12.5% - a big difference from the tax rate that they pay now. Plus they wont have to pay FICA and will live (hopefully) in a state where there is no income tax.

This will work out to a post-retirement income of $13K per month after taxes. We don't really know what will happen in the future with tax rates or social security, but you cant decide not to save or prepare because of that.


Joe
 

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I was involved with a discussion about tax rates and 401Ks recently. As a example, a couple in NYC are both employed and together fall into the 32% bracket. Not unusual in the city. The effective federal tax rate is less, probably around 23% or so, plus state, City and FICA. The left over pay is probably around 60 - 65% after that. The total effective tax rate (Federal plus state plus City plus FICA) is around 35 - 40%
Lets say you saved a decent amount in your 401k -- $2MM. Which is very possible if both spouses contribute the max during 30 years.
So a 4% minimum withdrawl is $80K. Plus 2 people getting the max SS payment of around $4K per month (Future estimate) will bring that total to $176K. Since you pay tax on 85% of SS, your taxable income is $161K, less the $24K standard deduction which comes to $137K. You pay only 12% on the first $77K and 22% on the balance. That comes out to $22K of tax. An effective rate of 12.5% - a big difference from the tax rate that they pay now. Plus they wont have to pay FICA and will live (hopefully) in a state where there is no income tax.

This will work out to a post-retirement income of $13K per month after taxes. We don't really know what will happen in the future with tax rates or social security, but you cant decide not to save or prepare because of that.


Joe

$13,000 monthly after-tax income is a nice retirement package especially if one moves from NYC to a less expensive state
 

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I feel lucky to maintain a 3-month rolling cash-flow budget.
I find CC charges too variable to project much beyond that.
.

same here but I suppose if one has only annuities and pensions for retirement then projecting 20 years in the future is possible .. assuming you live that long
 

VacationForever

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same here but I suppose if one has only annuities and pensions for retirement then projecting 20 years in the future is possible .. assuming you live that long
There are many components to a 20-year projection, and doing what-ifs:
- Listing down all expenses, now and projected increases/decreases. I have to project increased health care costs for myself each year until I reach Medicare age.
- Conservative grow in investment assets
- RMD withdrawal against the investments
- Social Security Income
- Annuities, if applicable
- Pension, if applicable
- Taxable investments interests/dividends and withdrawals

Lastly, if you have access to a Monte Carlo simulation program to see the probability of not running out of money.

The biggest surprise element that may happen is long term care expenses. If you don't already have a generous long term care insurance, you need to earmark a sum for funding of potential long term care.
 
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