Social Security: This 1 Simple Move Could Help You Avoid Taxes on Your Benefits
Key Points
Social Security benefits could be subject to both state and federal income taxes.
Most beneficiaries are already exempt from state taxes, but federal taxes are trickier to avoid.
The retirement account you choose can have a direct impact on the taxes you'll owe.
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It's tough to escape taxes, and even in retirement, you could owe both state and federal income taxes on your Social Security benefits.
There are exceptions, though, and it's simpler than you might think to (legally) get out of them. State taxes will depend on where you live, and with 42 U.S. states already making Social Security exempt, you might be free of this type of tax already.
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Federal taxes are a bit trickier, as they're based on your retirement income. However, there is one simple move to help reduce or even eliminate federal taxes on your Social Security: Invest in a Roth retirement account.
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How much could you owe in federal taxes?
Your federal taxes are based on a figure called your combined income. This is your adjusted gross income plus half of your annual Social Security benefit amount, along with any other sources of income, such as pensions, capital gains, dividends, or interest.
For example, say that your only two sources of income are retirement account withdrawals and Social Security. If you're pulling, say, $30,000 per year from your 401(k) while collecting $24,000 per year in benefits, your combined income would be $30,000 plus $12,000, or $42,000.
Depending on your combined income, you'll sit in one of three tax tiers:
| Percentage of Your Benefits Subject to Federal Taxes | Combined Income for Individuals | Combined Income for Married Couples Filing Jointly |
|---|---|---|
| 0% | Under $25,000 | Under $32,000 |
| Up to 50% | $25,000 to $34,000 | $32,000 to $44,000 |
| Up to 85% | Over $34,000 | More than $44,000 |
Data source: Social Security Administration. Table by author.
If these thresholds seem low, it's because they are. They haven't been adjusted since the 1980s, when Social Security benefits first became subject to federal taxes. Back then, less than 10% of beneficiaries owed federal taxes on their monthly checks, according to the Social Security Administration.
But as inflation and annual cost-of-living adjustments (COLAs) drive incomes higher, more retirees will owe federal taxes over time.
How to avoid federal income taxes on benefits
The simplest way to avoid federal taxes is to keep your combined income below $25,000 or $32,000 per year. But you don't necessarily have to reduce your actual income to lower your combined income.
Roth accounts, such as Roth IRAs and Roth 401(k)s, are not included in combined income calculations. If enough of your income comes from a Roth account, it could push your combined income low enough to at least reduce, if not eliminate, federal taxes.
Taxes can take a bite out of your Social Security, but a little planning can go a long way. By heading into retirement with a tax strategy, you can keep more of your hard-earned cash.
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