Best Ways to Minimize Taxes on Your Social Security Benefits

March 12, 2024 — The vast majority of people for whom Social Security is their only source of income generally won’t pay any taxes on their benefits. But it might come as a surprise to others that their Social Security benefits could count as taxable income. People with enough revenue from pensions, savings, Required Minimum Distributions, etc., might have to pay income taxes on up to 85% of their benefits. 

How are Social Security benefits taxed?

The law was changed in 1983 to help improve the stability of Social Security. After that, lower earners continued to get a break on their taxes, but higher earners now had to pay some taxes on their benefits. Over time the brackets have not expanded along with inflation, so an estimated 50% of people now pay some tax on their benefits. SS uses an adjusted gross income formula (earnings, investment income, retirement saving withdrawals and other taxable income, non taxable interest, and one half of Social Security benefits to determine what taxes might have to be paid.

Note that as Social Security benefits reach higher and higher levels due to recent record COLA payments, beneficiaries at the top of the pyramid may now have SS income that triggers taxation, even without any other types of income. Benefits for some beneficiaries are now over $50,000 per year, so half of that would be high enough to trigger taxation on 50% of a single person’s SS benefits.

Couples filing a joint return will pay no tax if their “combined income” is under $32,000.  Between that figure and $44,000, 50% of Social Security benefits are taxed. Once a couple’s combined income exceeds $44,000, 85% of the benefit is taxed.

3 Ways to Minimize Taxes on Your Social Security Benefits

Fortunately there are some legal and effective ways to minimize the tax you have to pay on your Social Security benefits. Here are some pretty good ideas that almost anyone can use.

Delay taking Social Security

At first blush this seems like a little bit of a crazy idea. Don’t take the benefit so you don’t pay taxes on it? But the strategy helps avoid what William Reichenstein, professor emeritus at Baylor University, calls the “tax tornado”. If you have retirement savings you can live on until age 70, you will not only increase your eventual benefit significantly, but you won’t be paying taxes on up to 85% of those benefits until you reach the age 70.  Every dollar of income over $44,000 means another 85 cents of Social Security income is taxed. By withdrawing some savings before age 70, you will also be minimizing how much you have to take out once your Required Minimum Distributions (RMDs) start (it will soon be age 75 for most people). Retirement distributions from non-Roth IRAs and 401(k)s are fully taxable. 

This concept is a little complicated but makes sense once you think about it. The only downsides seem to be that some people’s retirement balances can’t support early withdrawals, and you might risking missing out on bigger gains if you had left the money invested.

Contribute to a Roth

Distributions from retirement savings like IRAs and 401(k)s are taxable.  However, since Roth plan contributions were not deductible when you put them in, distributions from those plans can grow tax free, and are not taxed when you take them out. Therefore it might make sense to convert some of your regular IRA and 401(k) savings into a Roth plan. You will have to pay taxes on what you convert, but after that you will have major tax benefits. Some folks convert a portion of their savings every year. An ideal time to convert to a Roth is when you have a year with low taxable income or significant losses. If you can do it, the tax free withdrawals from a Roth might keep your “adjusted income” low enough to minimize Social Security taxes.  Consultation with a tax professional is essential to doing this effectively.

Think charitable

Assuming you make charitable contributions every year (a great idea!), a perfect way to accomplish that while minimizing your taxable income is to make a qualified charitable distributions (QCD) directly from your IRA custodian. Those donations will reduce your taxable distributions, and will not count as income. It is a great way to make the charitable donations you probably would have made anyway, while at the same time keeping your adjusted income low, and therefore minimize how much of your Social Security benefits are taxed. Note: QCDs from IRAs and 401(k)s are generally not deductible.

Two more ways to defeat taxes

There are certain states that tax Social Security benefits, which they tax in a variety of ways at different levels of income. To avoid those taxes you could avoid living in one of those states, notably Connecticut, Kansas, Missouri, Utah, Montana, Nebraska, New Mexico, Rhode Island, Vermont, or Utah. Note that each state has its own way of taxing benefits; and in many cases they might be minimal.

People could also choose to take Social Security as early as possible (age 62) and therefore get a minimal benefit to be taxed. To make up for that income, If they have very high balances in their non-Roth IRAs and 401(k)s, they could start taking money out of those funds well before RMDs kick in. That would have the effect of spreading out their distributions over many years and avoiding higher taxes in later years.

Bottom line

Yes, Margaret, you might have to pay taxes on your Social Security benefits. But the good news is that there are some strategies to help you minimize how much you have to pay. Just make sure you check with an expert advisor before you make any major moves.

Comments? Have you tried one of these strategies? Did it work the way you hoped it would? Please let us know in the Comments section below. 

For further reading:

Liz Weston’s excellent article: 3 Ways to Reduce Social Security Taxes

American Institute of CPA’s “Guide to Social Security Planning” by Ted Sarenski

Which States Tax Social Security Benefits