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How Social Security is taxed

Several factors determine whether or not you’ll pay taxes on your Social Security payments: marriage and total income.

To avoid taxes on your payments, your combined income must fall below $25,000 (single or widowed), or $32,000 (married). The U.S. federal government defines combined income as a sum of half your Social Security payments, nontaxable interest income and adjusted gross income.

Rise above these thresholds and you may have to pay taxes on 50% to 85% of your Social Security payment, depending on whether you live with your partner, are separated and filing separately, or filing jointly while cohabitating.

To find out how much you may owe, you’ll want to consult a financial adviser or accountant. Meanwhile, consider these steps to minimize your tax liability.

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1. Withdrawal from your retirement account

By reducing your combined income, you can cut Social Security taxes. You could do this by taking early withdrawals from your retirement accounts.

Most savers can tap their IRAs or 401(k)s as early as 59 1/2 years without penalty. This in turn would lower your tax burden once you become eligible for Social Security at age 62. But it could also cost you several years of compound interest on those investments, so weigh both sides of the leger carefully.

2. Move to a tax-advantaged state

Most states don’t tax Social Security benefits, but if you live in one of the 12 states that do it may be a good idea to move. Note that federal taxes still apply so you can’t eliminate taxes completely just by moving.

That noted, these nine states have no income tax at all:

  • Alaska
  • Florida
  • Nevada
  • New Hampshire
  • South Dakota
  • Tennessee
  • Texas
  • Washington
  • Wyoming

Read more: The average tax return in 2022 was over $3,000 — but are you getting as much money back as possible?

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3. Qualified longevity annuity contract (QLAC)

A qualified longevity annuity contract (QLAC) is a complex strategy that reduces taxes early in retirement (but could boost taxes later).

The contract is a special type of annuity that allows you to set aside a portion of your retirement account funds for later withdrawal.

The limit for this is 25% or $135,000 of the funds in your IRAs or 401(k)s.

4. Donations

Retirees over the age of 70.5 years can make a qualified charitable distribution (QCD). This transfers money from a traditional IRA to a qualified charity, ensuring that it counts as a donation and not ordinary income.

Effectively, this reduces your taxes on annual retirement benefits.

5. Adjusting gross income

How you get paid determines your tax liability. Business income, rental income, dividends and wages all count as gross income — so deducting business expenses or making qualified withdrawals from Roth IRA accounts could minimize taxes.

Be sure to consult a tax professional as some less-than-obvious expenses may qualify (like college tuition), while others (business clothing) do not.

All that to say, your Social Security benefits need not return to Uncle Sam. All it takes is the same sort of thoughtful planning and consultation that made your retirement savings possible in the first place. Creative thinking: What could be more patriotic?

Meet Your Retirement Goals Effortlessly

The road to retirement may seem long, but with WiserAdvisor, you can find a trusted partner to guide you every step of the way

WiserAdvisor matches you with vetted financial advisors that offer personalized advice to help you to make the right choices, invest wisely, and secure the retirement you've always dreamed of. Start planning early, and get your retirement mapped out today.

About the Author

Vishesh Raisinghani

Vishesh Raisinghani

Freelance Writer

Vishesh Raisinghani is a freelance contributor at MoneyWise. He has been writing about financial markets and economics since 2014 - having covered family offices, private equity, real estate, cryptocurrencies, and tech stocks over that period. His work has appeared in Seeking Alpha, Motley Fool Canada, Motley Fool UK, Mergers & Acquisitions, National Post, Financial Post, and Yahoo Canada.

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