Strategies to Minimize Taxes on $2,800 Monthly Social Security Income

Strategies to Minimize Taxes on ,800 Monthly Social Security Income

An elderly person benefits from their Social Security.

One of the biggest surprises future retirees face when planning their retirement finances is the fact that their Social Security the benefits could very well be subject to income tax.

A Financial Advisor can help you plan for your Social Security and potentially minimize your tax bill on your benefits. Connect with a Fiduciary Advisor Today.

One reason for this confusion is that they never saw their parents or grandparents pay taxes on their benefits. However, more retirees will likely pay taxes on their benefits in the future. In 2022, approximately 48% of Social Security recipients paid federal taxes on their benefits — a figure expected to rise to about 56% by 2050, according to one study. 2015 analysis published by the Social Security Administration.

How Social Security benefits are taxed

A retiree calculates how much of his or her Social Security benefits will be taxable. A retiree calculates how much of his or her Social Security benefits will be taxable.

A retiree calculates how much of his or her Social Security benefits will be taxable.

Due to rule changes first signed by President Ronald Reagan and then expanded by President Bill Clinton, Social Security recipients may be taxed up to 85% of their benefits based on their other sources of income . The formula for calculating tax is called “cumulative income” or “provisional income,” and it’s not exactly simple.

You can calculate your provisional or cumulative income by adding half of your annual Social Security benefits to your adjusted gross income (AGI), plus any tax-free interest paid to you. From there, income brackets determine the extent to which your benefits are considered taxable income.

None of your benefits are taxable if your provisional income is:

  • Less than $25,000 as a single filer

  • Less than $32,000 as a joint filer

Up to 50% of your benefits are taxable if your provisional income is:

  • Between $25,000 and $34,000 as a single filer

  • Between $32,000 and $44,000 as a joint filer

Up to 85% of your benefits are taxable if your pension income is:

  • Over $34.00 as a single filer

  • More than $44,000 as a joint filer

For example, let’s say you receive $2,800 per month in Social Security in 2024, which means you will receive $33,600 in total benefits in 2024. Now imagine that you will also withdraw $30,000 from an IRA. Your provisional income would therefore be $46,800 ($16,800 + $30,000). As a single filer, you would be taxed on up to 85% of your benefits since your provisional income exceeds the $34,000 threshold. According to this IRS calculator, you would pay income taxes on $15,380 of your benefits.

Remember, a Financial Advisor can help you better understand your tax liability in retirement, including how much of your benefits will be taxable and strategies to mitigate those taxes.

How to Minimize Social Security Taxes

There are several strategies you can use to potentially minimize the taxes you end up paying on your Social Security benefits:

  • Reduce or delay retirement withdrawals: Postpone or reduce withdrawals from an IRA, 401(k) or other tax-deferred account reduces or eliminates your provisional income. One strategy would be to withdraw money from a Roth IRA or Roth 401(k), which does not count as taxable income.

  • Manage your RMDs: At age 73 (or 75 for those who turn 74 after December 31, 2032), the IRS requires you to start taking required minimum distributions (RMD) from your IRAs, 401(k) and other tax-deferred accounts. If you are still working and have a 401(k) at that workplace, you are not required to take RMDs from that account. If you make a qualified charitable distribution (QCD) from an IRA, this amount can help satisfy your RMD but will not count as taxable income.

  • Roth conversion: Converting an IRA or 401(k) to a Roth IRA means you will pay income tax at the time of conversion, but qualified withdrawals in the future can be made tax-free and will not count in your combined income. However, you will likely have to pay taxes on your Social Security benefits in the year you convert the tax-deferred assets. One strategy is to convert just enough money to keep your taxable Social Security benefits at 50% or 0%.

  • Beware of the “tax torpedo”: Be aware that when the taxable amount of your benefits is added to your income, it could push you into higher income. tax bracket. This impact is known as Social Security tax torpedo. Remember to consider all your sources of retirement income when it comes to tax planning. A Financial Advisor can also help you avoid this tax torpedo and other financial retirement pitfalls.

Conclusion

How to manage and minimize the taxes you pay on your Social Security benefits and other retirement income can be complicated. Take the time to estimate your retirement taxes before you start collecting pensions, Social Security, and making withdrawals from retirement accounts.

Retirement Planning Tips

  • It is important to understand how required minimum distributions (RMDs) work and how they can impact your tax liability in retirement. These mandatory withdrawals from tax-deferred retirement accounts add to your taxable income and potentially push you into a higher tax bracket. Fortunately, SmartAsset has a RMD Calculator to help you estimate how much your first RMD will be and when it will be due so you can plan ahead.

  • Balancing taxes and retirement income is an important part of financial planning for retirement. A knowledgeable financial advisor can help you decide how to structure and coordinate your income plan to potentially minimize taxes. Finding a financial advisor doesn’t have to be difficult. The free SmartAsset tool connects you with up to three licensed financial advisors who serve your area, and you can have a free introductory call with your advisor to decide which one seems best for you. If you are ready to find an advisor who can help you achieve your financial goals, start now.

Photo credit: ©iStock.com/KenTannenbaum, ©iStock.com/ljubaphoto, ©iStock.com/Thurtell

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