How to Avoid Paying Taxes on Up to 85% of Your Social Security Benefits

Did you know that up to 85% of your Social Security benefits could be subject to income tax? This shocking fact catches many retirees off guard. After a lifetime of contributing to Social Security through payroll taxes, many Americans are surprised to discover that Uncle Sam wants another bite from their benefits check during retirement.

Most people don’t realize this tax trap exists until it’s too late. But you have more control over your Social Security taxes than you might think. With proper planning, you can potentially reduce or even eliminate taxes on your benefits.

The Social Security Tax Trap: How It Works

The taxation of Social Security benefits began in 1983 when Congress passed legislation to shore up the program’s finances. Initially, only 8% of retirees paid taxes on their benefits. Today, that figure has skyrocketed to 56% of beneficiaries.

Here’s how the tax works: If your “provisional income” exceeds certain thresholds, a portion of your Social Security becomes taxable. Provisional income includes your adjusted gross income, plus any tax-exempt interest and half of your Social Security benefits.

For married couples filing jointly:

• If your provisional income is below $32,000, none of your benefits are taxable
• If your provisional income is between $32,000 and $44,000, up to 50% of your benefits may be taxable
• If your provisional income exceeds $44,000, up to 85% of your benefits may be taxable

For single filers:

• If your provisional income is below $25,000, none of your benefits are taxable
• If your provisional income is between $25,000 and $34,000, up to 50% of your benefits may be taxable
• If your provisional income exceeds $34,000, up to 85% of your benefits may be taxable

The problem is especially serious because these thresholds aren’t indexed for inflation. When they were established in 1983, they affected relatively few retirees. The 85% threshold was added in 1993, and neither has been adjusted since. As a result, more and more retirees find themselves crossing these thresholds each year.

What is Provisional Income? What Goes Into the Calculation?

Provisional income is a special measurement used by the IRS to determine if your Social Security benefits will be taxed. It combines three different money sources:

1. Your regular taxable income before considering Social Security (your Adjusted Gross Income minus any Social Security income)
2. Any interest you earn that’s normally tax-free, like from municipal bonds
3. Half of what you receive in Social Security benefits

The formula looks like this:

Provisional Income =

AGI (excluding Social Security)

+ Tax-exempt interest

+ 50% of Social Security benefits

To calculate it yourself, you would add together your non-Social Security AGI, plus all tax-exempt interest, plus 50% of your annual Social Security benefits. This total determines whether—and how much of—your Social Security benefits will face taxation.

In simple terms, it’s the IRS’s way of looking at your complete income picture, including some money that wouldn’t normally be taxed, to decide if your Social Security benefits should be partially taxed.

The Tax Torpedo: When Social Security and Other Income Collide

The taxation of Social Security creates what experts call a “tax torpedo.” This occurs when your Social Security benefits push you into a higher tax bracket, potentially causing your marginal tax rate to more than double.

Consider this example: Let’s say you and your spouse receive $36,000 annually in Social Security benefits. Half of that amount ($18,000) counts toward your provisional income. If you have other income from pensions, IRAs, or other sources that pushes your total provisional income over $44,000, up to 85% of your Social Security benefits ($30,600) could be subject to income tax.

Now, imagine you reach age 73 and must begin taking Required Minimum Distributions (RMDs) from your retirement accounts. These mandatory withdrawals could increase your income, potentially causing more of your Social Security to be taxed at higher rates.

As Ryan Thacker from B.O.S.S. Retirement Solutions explains: “What you see over time is you see, okay, I started with my Social Security benefit when I first started retirement. And then I got to age 72 and I started taking these required minimum distributions. And then that pushed me into a higher tax bracket.”

The 2023 COLA Increase: A Double-Edged Sword

In 2023, Social Security recipients received an 8.7% cost-of-living adjustment (COLA)—the largest increase in 40 years. While this boost helps offset inflation, it has a potential downside.

As Tyson Thacker points out: “The higher monthly benefit amount because of the 8.7% actually could push you into a higher tax bracket or cause your Medicare premiums to go up because you’re getting a much bigger amount.”

This highlights the interconnected nature of retirement planning. What seems like good news on one front can create challenges on another.

Strategies to Reduce or Eliminate Taxes on Your Social Security

Now for the good news: With proper planning, you can take steps to reduce or potentially eliminate taxes on your Social Security benefits. Here are several effective strategies:

1. Strategically Time Your Retirement Account Withdrawals

One of the most powerful ways to control the taxation of your Social Security benefits is to carefully manage withdrawals from your retirement accounts.

Consider making withdrawals from tax-deferred accounts like traditional IRAs before you begin collecting Social Security. This “fill up the lower tax brackets” strategy can reduce your income in later years when Social Security begins, potentially keeping you below the taxation thresholds.

2. Consider Roth Conversions

Roth IRAs offer unique advantages when it comes to Social Security taxation. Unlike traditional IRA withdrawals, qualified Roth distributions don’t count toward your provisional income.

By converting some of your traditional IRA assets to Roth accounts before you begin collecting Social Security, you can reduce your taxable income during retirement.

Here’s a real-world example shared by B.O.S.S. Retirement Solutions: They worked with a client who had $660,853 in a tax-deferred account. Without planning, this client would have paid approximately $941,334 in taxes over their lifetime. By strategically converting portions to Roth accounts, they reduced their tax liability to $218,081 – saving over $723,253 in taxes.

3. Use Qualified Charitable Distributions (QCDs)

If you’re 70½ or older, you can make qualified charitable distributions directly from your IRA to eligible charities. These distributions don’t count toward your adjusted gross income, which helps keep your provisional income lower.

QCDs can satisfy your Required Minimum Distributions without increasing your taxable income, potentially reducing the tax bite on your Social Security benefits.

4. Consider Tax-Free Income Sources

Certain investments provide income that doesn’t count toward your provisional income calculation. These include:

• Life insurance cash values when accessed properly
• Roth IRA distributions
• Certain municipal bonds (though these may affect other tax calculations)

By structuring your retirement income to include these tax-free sources, you can keep your provisional income below the taxation thresholds.

5. Time Your Social Security Claiming Decision

When you claim Social Security can significantly impact your lifetime tax situation. While many factors go into this decision, tax considerations should be part of your analysis.

You might consider delaying Social Security while taking distributions from your retirement accounts if you have substantial retirement savings. This approach can reduce the overall size of your retirement accounts (reducing future RMDs) while increasing your eventual Social Security benefit.

However, as the experts at B.O.S.S. Retirement Solutions caution, this isn’t a one-size-fits-all strategy. Your optimal claiming strategy depends on your overall financial situation, health outlook, and other factors.

The Importance of Comprehensive Planning

The key takeaway is that Social Security taxation doesn’t happen in isolation. It’s connected to your overall retirement income strategy, including:

• When and how you claim Social Security
• How you withdraw money from retirement accounts
• Your Medicare premiums (which can increase based on income)
• Your other income sources

As Tyson Thacker points out, “It’s not how much you make, but what you keep.” This principle is especially important regarding Social Security.

Ed Slott, known as “America’s IRA tax expert,” says, “If you have an IRA, you really have an IOU to Uncle Sam.” Your goal should be to structure your retirement income to minimize that IOU while maximizing what stays in your pocket.

Why It Matters: The Impact on Your Retirement

The difference between a well-planned approach to Social Security taxation and no planning at all can be substantial. According to Forbes, 96% of Americans lose an average of $111,000 in Social Security income – often due to tax issues and poor claiming strategies.

For some retirees, the tax savings can be much more significant. B.O.S.S. Retirement Solutions has helped clients save hundreds of thousands of dollars through proper tax planning around Social Security.

Remember: These are taxes you could legally avoid with proper planning. This isn’t about tax evasion – it’s about tax efficiency, using the rules established by Congress to your advantage.

Taking Action: Next Steps

To maximize your Social Security benefits and minimize taxes, consider taking these steps:

1. Get a clear picture of your expected retirement income from all sources
2. Project your potential tax situation, including Social Security taxation
3. Explore strategies to reduce your provisional income
4. Consider working with a financial advisor who specializes in retirement income planning and Social Security strategies

The best time to start planning is well before retirement – ideally in your 50s when you have more options available. But even if you’re already collecting Social Security, there may be strategies that can help reduce your tax burden.

The Bottom Line

Your Social Security benefits represent a significant portion of your retirement income. By understanding how these benefits are taxed and implementing strategies to minimize that taxation, you can potentially save tens of thousands of dollars over your retirement years.

Remember: It’s not the Social Security Administration’s job to help you minimize taxes. That responsibility falls on you and your financial advisors. With careful planning, you can potentially reduce or even eliminate taxes on your Social Security benefits, keeping more of your hard-earned money in your pocket where it belongs.

To discover how you could reduce or eliminate taxes on your benefits with a free customized B.O.S.S. Retirement Solutions Social Security benefit analysis, click here to get your free analysis. If you’ve saved at least $200,000 for retirement and have not yet filed for social security, this ends up being a turnkey solution that could help ensure that you get the most out of your social security benefits.