Strategies to Reduce Taxes on Social Security Benefits

One of the items that many people rely on for retirement planning is Social Security. You know that you will likely receive Social Security benefits (although they might be reduced).

However, Social Security benefits are also among the surprising things you pay taxes on. Depending on your income level, and where that money is coming from, you might have to pay more than you expected in taxes as a significant portion of your Social Security benefits is taxed.

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It’s never to early to plan for retirement, and it’s never too early to consider how you might reduce your tax liability in the future.

Put Off Taking Social Security

If you want to reduce the amount of tax you pay on Social Security benefits, you can delay taking them. Deciding when to begin taking Social Security is a big decision. You’ll need to take into account a number of factors.

The longer you delay taking Social Security benefits, the longer you draw on your retirement account. If you can draw down your retirement account before you begin taking Social Security benefits, you can reduce your assets, as well as what you will have to take in Required Minimum Distributions (RMDs) after you reach the age of 70 1/2. With this other income reduced, you will be subject to lower taxes on your Social Security benefits.

As you can see, coordinating your retirement efforts is important. You need to consider how your RMDs will impact your tax situation, as well as what it all means when combined with Social Security benefits. It’s important to get the big picture as you try to figure out when to withdraw money from various accounts, and when to begin taking Social Security.

Use a Roth IRA

One of the best retirement tools out there is the Roth IRA. With a Roth IRA, you pay taxes on your money before you contribute it. However, the money grows tax free. You don’t have to worry about it adding to your taxable income later, and your withdrawals won’t lead to an increase in taxes on your Social Security benefits.

On top of that, RMDs aren’t a part of the Roth IRA. You can withdraw as little or as much as you need each year during retirement with the Roth IRA, and you don’t have to worry about penalties.

If you convert your retirement accounts to a Roth IRA (and anyone can, regardless of income) now, you can save money later. You can reduce your tax bite in the future on a number of levels. However, you will increase your tax bite now.

The amount of money that you roll over into a Roth IRA is going to be taxed at your current marginal rate. Uncle Sam wants his cut, and he’ll get it. However, if you think that you will be most likely to see higher taxes in the future, paying them now can be a good strategic move. Consider rolling over portions of your non-Roth retirement accounts into a Roth IRA a little bit at a time. You can spread it out over the course of a few years in order to reduce the impact the taxes will have on your finances.

There are other ways to protect some of your money as well, such as using a deferred annuity to shelter some of your assets until later. However, you need to be careful of annuities, since they can come with their own tax issues, and can also cause issues for beneficiaries.

Bottom Line

It’s essential that you look ahead with your retirement planning. If you want to improve your tax efficiency, and legally reduce what you owe in taxes during retirement, you need to make a coordinated effort. Think about how your retirement account distributions will affect your situation, as well as how your Social Security benefits might be taxed as a result. A knowledgeable financial planner or retirement planning expert can help you make a plan to manage your retirement taxes more efficiently.

About the Author

By , on Apr 8, 2013
Miranda Marquit
Miranda is a professional personal finance journalist. She is a contributor for several personal finance web sites. Her work has been mentioned in and linked to from, USA Today, The Huffington Post, The San Francisco Chronicle, The New York Times, The Wall Street Journal, and other publications. She also has her own personal finance blog: Planting Money Seeds.

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Leave Your Comment (One Comment)

  1. Mike @ Annuity Rates says:

    Every retiree has his own savings that they need to turn into a source of income. And annuity is designed exactly to do so. That’s why there is a logical appeal to annuity. Annuity is also a tax deferred investment. Among different types of annuity products Fixed annuity is more suitable for those closing to their retirement.

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