Social Security can generate real income.
The more you earned during your working life, up to each year’s income caps, the more you receive in benefits during your retirement. In 2024, someone with maximum credits who waits until age 70 will receive almost $60,000 per year in benefits.
But, as always, more money means more taxes. While you don’t owe payroll (or “FICA”) taxes on Social Security benefits, since those only apply to earned income, the IRS can levy income taxes on them. Here, with benefits of $3,500 per month, you will probably owe some taxes.
Here’s what you need to know about managing those taxes, and you can talk to a financial advisor for more guidance.
How Social Security Benefits Are Taxed
Social Security benefits are taxed based on a system called “combined income.” This is calculated as your:
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Adjusted Gross Income, or “AGI,” plus
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Any nontaxable interest, plus
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Half of your Social Security benefits
So, for example, say that you withdraw $75,000 in taxable income from your retirement portfolios in addition to your current $42,000 per year in benefits. Your combined income would be $96,000 (AGI + 0.5*Benefits = $75,000 + (0.5 * $42,000) = $96,000)
From there, the your taxes are assessed based on filing status.
For individuals, the tiers are:
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Combined income below $25,000 – No benefit taxes
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Combined income between $25,000 – $34,000 – Income taxes on up to 50% of your benefits
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Combined income above $34,000 – Income taxes on up to 85% of your benefits
For joint filers, the tiers are:
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Combined income below $32,000 – No benefits taxes
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Combined income between $32,000 – $44,000 – Income taxes on up to 50% of your benefits
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Combined income above $44,000 – Income taxes on up to 85% of your benefits
Married individuals filing separate returns almost always pay income taxes on their benefits.
These tiers are not tax rates. This is the percent of your Social Security income that is taxed as part of your income. So, take our example above. With $96,000 of combined income, you would add up to $35,700 to your taxable income. (0.85 * Benefits = 0.85 * $42,000 = $35,700)
Need help minimizing your taxes? Match with a financial advisor today.
How Can You Reduce Social Security Taxes?
Strategies to reduce your benefits taxes typically start in the same place: You have to reduce your taxable income. At each tier of combined income, your taxed benefits increase. So to reduce those taxes, you have to adjust where you fall on those tiers.
Here, you are starting with $21,000 in combined income. ($3,500 * 12 / 2 = $21,000) This isn’t enough to trigger taxes for either an individual or a joint filer. Your taxes, then, will depend on your other sources of retirement income. A few strategies to reduce those taxes include:
Make a Roth Conversion
Perhaps the most straightforward option is to convert all or part of your retirement assets into a Roth IRA. Once you do this, those withdrawals will not count as taxable income. This can help keep your AGI down, even zeroing it out if you convert everything to a Roth fund, which in turn reduces your combined income.
The problem with this strategy is up-front cost. To make a Roth conversion you will need to pay income taxes all at once on the amount you convert. It will not only be expensive, it may actually lose you money in the long run depending on how your tax rates fall out. You also cannot make penalty-free withdrawals from a Roth IRA within five years of opening it.
A financial advisor can help you build a Roth IRA conversion strategy.
Adjust Your Withdrawals
You can manipulate how and when you take income. Specifically, you can manage your withdrawals to min/max your taxable income from year to year based on how the Social Security tiers.
For example, you collect $42,000 in total benefits right now. Say that you want to live on $80,000 per year. You would withdraw another $38,000 from your retirement accounts giving you $59,000 in combined income. ($38,000 + (0.5 * $42,000) = $59,000)
Since this puts you over the 85% tier, you’ve already maxed out your benefits taxes for this year. You won’t increase your benefits taxes by increasing your income.
So, you could withdraw $76,000 from your retirement account instead. This will give you a combined income of $97,000 ($21,000 + $76,000 = $97,000), still at the 85% tier, but you would have next year’s income already withdrawn. So, with no withdrawals, next year you would have a combined income of $21,000 and trigger no benefit taxes at all.
Now, this is a clumsy example used just for the purposes of demonstration. In reality, you would want to plan more carefully so that you don’t replace benefit taxes with portfolio income taxes. But used wisely, this approach can save you real money. A financial advisor can help you weigh the costs and benefits of your options.
Bottom Line
There may be other ways to reduce your AGI and lower your overall tax bill, such as through deductions for charitable gifting, or taking advantage of tax credits. But at the higher end of the Social Security benefits scale, you’ll most likely face taxes on a majority of your benefits if you’re receiving retirement income from a taxable portfolio. Fortunately, there are potentially ways to reduce that burden.
Retirement Tax Tips
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Different categories of income have different tax rules and rates. For your retirement, it’s essential that you understand the federal tax rules for all of your different types of retirement income.
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A financial advisor can help you build a comprehensive retirement plan. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.
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