Don't believe claims that Social Security benefits are now tax-free. Sure, a "senior bonus" passed by Congress will help lower federal taxes on Social Security benefits for many retirees. However, this deduction is only temporary: It expires in 2028. Even with the deduction, though, some will still owe some taxes on their Social Security benefits.
The trick to minimizing how much tax you must pay on your benefits is to reduce your combined income (adjusted gross income plus non-taxable interest plus half of your Social Security benefit). Here are seven simple steps you can take to lower your Social Security benefit taxes.
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1. Delay claiming Social Security benefits
If you haven't already begun receiving Social Security retirement benefits, hold off on claiming them. Delaying until your full retirement age -- or even better, age 70 -- gives you more time to make strategic moves to ensure your combined income is lower when you do start receiving Social Security benefits.
Granted, waiting to claim Social Security will increase your monthly benefit. However, it doesn't necessarily translate into higher taxes if you reduce other income sources first.
2. Withdraw from traditional IRAs before claiming Social Security
One smart step to take before claiming Social Security is to withdraw money from traditional IRAs. You're allowed to begin taking money out of traditional IRAs with no penalty at age 59 1/2.
Why draw down your traditional IRAs before claiming Social Security? It reduces the size of your future required minimum distributions (RMDs). As a result, your taxable income will be lower down the road.
3. Convert your traditional IRA to a Roth IRA before claiming Social Security
Another strategy is to convert your traditional IRA to a Roth IRA. This should ideally be done before claiming Social Security. The downside of this approach is that you must pay taxes on the traditional IRA upfront. Make sure you have enough cash to cover this cost first. The upside, though, is that none of your future Roth IRA distributions will count toward your combined income. As a result, your taxes on Social Security benefits will be lower.
4. Withdraw from Roth IRAs after claiming Social Security
Let's now shift to things you can do to reduce your Social Security benefit taxes after you've claimed Social Security. Withdrawing from Roth IRAs is one easy step to take because, as we have already discussed, they don't count toward your adjusted gross income for federal taxes.
5. Use Qualified Charitable Distributions (QCDs)
Once you reach age 70 1/2, you can take advantage of a powerful tool called a qualified charitable distribution (QCD). Using QCDs allows you to direct withdrawals from a traditional IRA to a charity. Since you never receive the money, it doesn't count as taxable income. Importantly, though, QCDs do count toward your RMD.
6. Shift to tax-efficient investments
If you have taxable brokerage accounts, shifting your money to tax-efficient investments can lower your combined income. Index funds tend to be tax-efficient. Dividend stocks, on the other hand, aren't because dividends count 100% as income in the Social Security benefit tax formula. Capital gains only count when you sell stocks.
One warning: Be careful buying municipal bonds. Although interest from municipal bonds is free from federal income taxes, it is included in Social Security's benefit tax formula. It's possible that your municipal bond interest could be enough to push you into a higher tax bracket.
7. Coordinate withdrawals with your spouse
If you're married, you'll definitely want to coordinate withdrawals with your spouse. This is especially important in managing RMDs. Even if you haven't reached the RMD age threshold, this approach is still a good idea.
For example, suppose you receive a large Social Security benefit, and your spouse has a large IRA. If you make significant withdrawals from your spouse's IRA, it could push your combined income to a level where 85% of Social Security benefits are taxed.
Have a "keep-more-of-your-money" mindset
During your working career, you probably focused primarily on deferring taxes. Your mindset will need to change when you begin receiving Social Security benefits. If you manage the timing of your income using the above steps, you should be able to keep more of your money where it belongs -- in your hands rather than Uncle Sam's.
