Key Points
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If you’re withdrawing money from a retirement fund, monitor how those withdrawals impact your adjusted gross income and tax rate.
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Even after retirement, it’s vital to regularly review and adjust your withdrawal strategy.
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To minimize taxes, carefully time payouts on all tax-deferred assets.
Despite a bit of confusion earlier this year, Social Security benefits remain a source of taxable income. The percentage you’ll pay depends primarily on how much you bring in. While a new deduction for those 65 and older may offset how much you owe, up to 85% of benefits may be taxed.
The ever-present goal of personal finance is to save money where possible and put that money to better use. When it comes to Social Security benefits, saving money means minimizing taxes. Here’s how to do just that.
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The role “combined income” plays
Taxes on Social Security benefits are based on combined income and filing status. To find your combined income, add together all sources of household income, including earnings, rental income, and investments. From that total, subtract deductions and exclusions. The amount you’re left with is the income the Social Security Administration (SSA) will use to determine the percentage of your Social Security benefits that may be taxable.
Here’s how much you can expect to pay taxes on, based on combined income and filing status:
Married filing jointly
|
Combined Annual Income |
Taxable Percentage of Social Security Benefit |
|---|---|
|
$32,000 or less |
None |
|
$32,000-$44,000 |
Up to 50% |
|
More than $44,000 |
Up to 85% |
Data source: IRS.
Filing single, head of household, or qualifying widow or widower
|
Combined Annual Income |
Taxable Percentage of Social Security Benefit |
|---|---|
|
$25,000 or less |
None |
|
$25,000-$34,000 |
Up to 50% |
|
More than $34,000 |
Up to 85% |
Data source: IRS.
Watch your tax bracket (and plan ahead when possible)
As you plan for retirement, you may regularly contribute to a retirement account, like a 401(k) or IRA, and that’s vital to retirement planning. However, as you strategize ways to minimize taxes in retirement, it’s essential to keep an eye on how much you can withdraw each year without pushing yourself into a higher tax bracket.
Imagine you’re single and bringing in an annual combined income of $47,000. That puts you near the top of the 12% tax bracket. You may plan to withdraw an extra $10,000 from your retirement account this year to make improvements around the house or take a nice trip. That additional $10,000 is enough to push you into the 22% tax bracket, a fairly significant jump to make at one time.
Since some retirement account withdrawals increase your combined income and impact your tax rate, it helps to have a plan. For example, if you know that you’ll eventually make updates to your home, build a home renovation fund by withdrawing a little more than usual every year until you have enough to make the changes you desire.
Don’t forget about other tax-deferred assets
Let’s say you’ve purchased a deferred annuity, a financial contract that allows you to build funds over time and receive a steady stream of payments at a later date.
If you can swing it financially, structure the deferred annuity to begin paying income when you expect your taxable income and overall tax rate to decrease. That may mean waiting until later in retirement when you suspect you’ll get by with smaller withdrawals.
Delay claiming benefits
Your Social Security benefits increase by 8% each year you defer claiming them after full retirement age (FRA). While the 8% increase ends at age 70, the extra monthly benefit can help you enjoy a more comfortable retirement. While it may not lower your taxes, it will give you more wiggle room to pay them.
If you’re working, be strategic about how much you earn
If you’re still working but receiving Social Security benefits, it’s important to factor in how much the SSA will withhold from your benefit until you hit FRA. For example:
- Under FRA: $1 will be deducted from your benefit for every $2 earned over $23,400.
- The year you reach FRA (but haven’t celebrated a birthday yet): $1 will be deducted for every $3 earned above $62,160.
- FRA: There is no earnings limit, and your benefits will not be reduced.
Here’s the tricky (but nice) bit: That money the SSA withholds from your monthly benefits? Your monthly payments will be recalculated the month you reach FRA, and the SSA will credit back the amount it previously deducted. Although it’s excellent news, it will add to your annual income and should be factored in before determining how much to withdraw from other sources, like retirement accounts. Again, the goal is to ensure you remain in the lowest possible tax bracket.
The ultimate goal is to be as comfortable as possible in retirement. Whether that means maximizing the amount of Social Security you receive, minimizing the tax you pay, or a combination of both is up to you.
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