The Sneaky Reason You Might Lose a Chunk of Your Social Security Income

Social Security is an important income source for many seniors — including those who do have additional income streams at their disposal in retirement. Say you manage to amass a decent-sized nest egg. Your savings might provide you with, say, $20,000 of income a year. If you're used to living on a lot more, Social Security can help pick up the slack.

But many seniors are shocked to learn that they're not entitled to their Social Security income in full. That's because even low to moderate earners are subject to having their benefits taxed at the federal level. And if that happens to you, it'll cause your Social Security paycheck to shrink.

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Will you lose a chunk of your benefits?

Whether your Social Security income will be taxed will hinge on your provisional income. That's calculated by taking half of your annual benefit amount and adding it to your non-Social Security income.

If your provisional income is $25,000 or more and you're single, you'll face taxes on your Social Security benefits. The same holds true if you're married with a provisional income of $32,000 or more.

Clearly, these aren't large thresholds. Say you're single and are entitled to $1,500 a month, or $18,000 a year, from Social Security. If you also withdraw $20,000 a year from your nest egg and that's your only other income source, you'll have a total annual income of $38,000 and a provisional income of $29,000. That already puts you in a place where your benefits get taxed — even though an annual income of $38,000 does not make you a wealthy retiree by any means.

How to avoid taxes on Social Security

The fact that there are such low thresholds at which taxes apply to Social Security puts many seniors at a disadvantage. But there's one thing you can to reduce your chances of having those benefits taxed down the line — save in the right retirement plan.

If you house your retirement savings in a Roth IRA, your withdrawals from that plan won't count toward provisional income. So, going back to our example, if you take $20,000 a year out of a Roth IRA and have no other income, and you collect $18,000 a year from Social Security, you'll keep your annual income of $38,000. However, you'll slash your provisional income to $9,000, thereby getting out of paying taxes on the money Social Security pays you.

While Roth IRAs don't offer the same immediate tax break you'll get by funding a traditional IRA, withdrawals in retirement are tax-free. And Roth IRAs also offer the benefit of letting you keep your money in your account indefinitely, whereas all other tax-advantaged retirement plans impose required minimum distributions.

Keep more of your money

Social Security may end up being an important income source for you down the line, so it pays to take steps to hang onto as much of your benefits as possible. By saving strategically, you may be able to avoid taxes on your benefits — at least at the federal level. There are some states that tax Social Security, but many of those at least offer exemptions so that low and moderate earners aren't hit with that burden.

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