5 Clever Ways to Avoid Taxes on Social Security Benefits

As long as you qualify for Social Security retirement benefits, you can start getting payments as early as age 62. The payments won’t make you rich, but they provide income to help you meet your financial needs in retirement.

Although it may seem like Social Security benefits shouldn’t be taxed, that isn’t always the case. If your total income is high enough, you have to pay income tax on your Social Security benefits. You can make smart tax moves to avoid paying Social Security taxes, as long as you do so according to the rules. Learn what those moves are so you can minimize your taxes on Social Security benefits.

How is Social Security taxed?

Under IRS rules, Social Security benefits may be taxed if you make more than a certain income level for your filing status. The type of income used for determining this is called combined income.

Combined income isn’t a line item you’ll find on your 1040 tax form. It’s a term used specifically for calculating taxes owed on Social Security benefits. According to the Social Security Administration (SSA), your combined income is calculated starting with your adjusted gross income, which is a line on your income tax return, then adding nontaxable interest and half of your Social Security benefits. Tax-exempt interest typically comes from certain types of bonds.

The combined income formula looks like this:

Adjusted gross income + Nontaxable interest + Half of your Social Security benefits = Combined income

After you have your combined income, you can figure out how much of your benefits are taxable based on your tax filing status. Here are the thresholds taxpayers need to know for the 2023 tax year, which will be filed this year, for each tax filing status.

Single filers, head of household, qualifying widow, or qualifying widower

If you have a combined income of …

• Up to $25,000: Social Security benefits are generally not taxable
• Between $25,000 and $34,000: Up to 50% of your Social Security benefits may be taxed
• Over $34,000: Up to 85% of your Social Security benefits may be taxed

Married couples filing a joint return

If you have a combined income of …

• Up to $32,000: Social Security benefits are generally not taxable
• Between $32,000 and $44,000: Up to 50% of your Social Security benefits may be taxed
• Over $44,000: Up to 85% of your Social Security benefits may be taxed

Married filing separately and lived apart from your spouse for all of 2022

If you have a combined income of …

• Up to $25,000: Social Security benefits are generally not taxable
• Between $25,000 and $34,000: Up to 50% of your Social Security benefits may be taxed
• Over $34,000: Up to 85% of your Social Security benefits may be taxed

Married filing separately and lived with your spouse at any time during 2022

• You will likely pay taxes on up to 85% of your Social Security benefits.

If this sounds complicated, the best tax software will automatically calculate whether your Social Security benefits are taxable. The IRS also has a worksheet to help you determine whether your benefits are taxable.

5 ways to lower taxes on Social Security benefits

Learning how to manage your money to minimize taxes could put you in a much better financial position. Here are a few ideas to potentially help you lower the taxation of Social Security benefits.

1. Make retirement withdrawals before you start receiving Social Security benefits

Keeping the total amount of your combined income below the taxable benefit threshold is key in lowering taxes on your Social Security benefits. Withdrawals from traditional retirement plan accounts, such as individual retirement accounts (IRAs) or 401(k)s, are included in your adjusted gross income. This is also included in your combined income. If you’re withdrawing money from your traditional retirement account while receiving Social Security benefits, this could result in your Social Security benefits being taxable.

You can start receiving Social Security benefits as early as age 62. Even so, you get a larger payment if you wait until you’re older to start receiving benefits. Even if you start receiving Social Security benefits at age 62, however, you can withdraw money from your traditional retirement accounts before you start taking Social Security benefits. You can start withdrawing money from these accounts without an early withdrawal penalty after age 59 1/2.

Withdrawing money from traditional retirement accounts before starting Social Security could reduce the amount you have to take out when claiming Social Security benefits, resulting in potentially paying less in taxes. If you wait until your full retirement age or later to receive Social Security, you’ll also receive a larger Social Security benefit payment each month, so some may find it beneficial to wait to take Social Security and withdraw funds from traditional retirement accounts while you wait.

2. Live in a state that doesn’t tax Social Security

Most states don’t tax your Social Security benefits. Although this won’t help you decrease your federal income tax burden, every little bit helps when living on a tight budget.

The states that do tax your Social Security income are: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, and Vermont (North Dakota and West Virginia no longer tax Social Security benefits). These states may offer partial exemptions, though, depending on your age or income.

Learn how your state taxes Social Security benefits. If your state is one of the states that tax benefits, you could potentially save money on state income taxes by moving to a state that doesn’t have a state income tax at all or one that doesn’t charge state tax on Social Security benefits.

Of course, moving can be costly and results in several lifestyle changes. Doing so should not be taken lightly.

3. Consider buying a qualified longevity annuity contract

A qualified longevity annuity contract (QLAC) could help retirees reduce the taxes on their Social Security benefits early in retirement but may increase their taxes later in retirement. These are a special type of annuity that allows you to set aside up to 25% or $135,000 of the money in your traditional retirement accounts.

Essentially, you reduce the amount of money in your retirement accounts which also reduces the required minimum distributions (RMDs) you have to make. You eventually start receiving income from the QLAC, which results in potentially higher taxes on your benefits later in life.

Annuities are also known for having high fees that may reduce your returns. Although this may be an option, it could be a costly option where the costs outweigh the benefits. Scrutinize any QLAC closely and make sure you fully understand the risks and benefits before signing up.

4. Donate your RMD

If you’re receiving required minimum distributions, or RMDs, from you retirement accounts, you may have an option to completely eliminate them from your income by donating them. A special type of charitable contribution, called a qualified charitable distribution (QCD), allows you to directly transfer funds from a traditional IRA to a qualified charity.

To qualify for a QCD, you must be at least age 70 1/2. The money has to come out of your IRA by the RMD deadline of December 31. The money must go directly to the charity by having your custodian issue a check in the charity’s name.

By doing so, the money is never counted in your income and goes directly to the charity. It also counts as up to $100,000 of your required minimum distributions each year. The downside is you don’t get access to the money. In reality, this method means you’re donating more money than you’d pay in taxes by receiving the income yourself.

5. Lower your adjusted gross income

Adjusted gross income includes many factors, such as wages, interest, dividends, capital gains and losses, business income, pension payments, and more. To lower this income, you should look for ways to receive income that aren’t included in adjusted gross income. For example, qualified withdrawals from Roth IRAs aren’t considered taxable income, so they do not add to your adjusted gross income.

Adjusted gross income is calculated before taking the standard or itemized deductions into account. That means you cannot lower your AGI by making traditional charitable contributions or by paying state income taxes. You could, however, reduce your AGI by any business losses you incur or by up to $3,000 in net capital losses each year.

The key is remembering you need money to live. Don’t simply make a move to save a portion of a dollar in taxes if it costs you a whole dollar to do so. If you do, you’re losing more money than you’re saving. For example, if you need extra funds from a part-time job to make ends meet, it may be best to continue bringing in those funds, even if they increase your taxes.

FAQs

Bottom line

Figuring out how much tax you owe on your Social Security benefits may feel complicated. Thankfully, tax software can automatically calculate any potential tax liability for you when preparing your tax return. You can also consult a tax expert, such as a certified public accountant (CPA), who should be able to walk you through the calculations for a fee.

A tax expert or financial advisor could also help you decide what retirement income to use and when. Learn more about what financial advisors do and how they might be able to help you meet your retirement goals.