How to Reduce Taxes on Your Social Security Payments

Is Social Security Taxed? TurboTax Tax Tips Video
Is Social Security Taxed? TurboTax Tax Tips Video

By Emily Brandon

Your Social Security payments in retirement might be taxable, depending on how much you earn and the sources the money comes from. About 40 percent of Social Security beneficiaries pay taxes on their benefits. Here's how to minimize the taxes you pay on your Social Security income.

Keep Your Income Below the Threshold

If your only source of retirement income is Social Security, you probably won't have to pay tax on your payments. "Most people do not have enough income to hit the threshold and have any of their Social Security income be taxable," says Nancy Altman, co-chair of the Strengthen Social Security coalition and co-author of "Social Security Works! Why Social Security Isn't Going Broke and How Expanding It Will Help Us All."

However, once the sum of your adjusted gross income, nontaxable interest and half of your Social Security benefit tops $25,000 for individuals and $32,000 for couples, you may have to pay income tax on up to 50 percent of your Social Security benefit. And if these retirement income sources top $34,000 for individuals and $44,000 for couples, up to 85 percent of your Social Security payments may be taxable.

But no workers pay income tax on 100 percent of their Social Security retirement benefit under current law. "Increasingly, more people will be paying because the thresholds that are being used are not adjusted for inflation or changes in average wages," says Eric Kingson, a professor of social work at Syracuse University. "It will extend down over time to more of the middle class." Workers collectively paid $20.7 billion in taxes on their old-age and survivors insurance benefits in 2013.

Know Which Income Sources Will Make Your Benefit Taxable

If you continue to work after signing up for Social Security and receive wages or self-employment income, that could push your income over the threshold and make your benefit taxable. Interest, dividends, taxable pension payments, traditional 401(k) and individual retirement account withdrawals and other taxable income could also lead to part of your Social Security benefit being taxable. Tax-exempt interest income, such as interest earned on municipal bonds or U.S. savings bonds, must also be included in the calculation that determines whether your Social Security benefit will be taxable.

However, money withdrawn from Roth accounts in retirement, which is typically not a taxable event, will not contribute to making your Social Security benefit taxable. "If you covert your regular IRA or 401(k) to a Roth, when you take the money out, there are not tax implications for Social Security," says Laurence Kotlikoff, an economics professor at Boston University and co-author of "Get What's Yours: The Secrets to Maxing Out Your Social Security." "The Roth money is not going to affect your Social Security taxes."

Another strategy to minimize Social Security taxes is to draw down your pretax 401(k) and IRA balances before signing up for Social Security, which will get you higher Social Security payments due to delayed claiming and lower or no taxes on the benefit. "You've got to get the money out of your 401(k) at some point, and you might want to do that before you start taking your Social Security benefit," Kotlikoff says. "You could take your 401(k) money out first and then start taking Social Security."

Have Your Income Tax Withheld

If you have to pay taxes on your Social Security benefit, you can make quarterly estimated tax payments or have the federal tax withheld from your benefit. To have the taxes deducted from your payments, you will need to fill out IRS form W-4V. Social Security beneficiaries can elect to have 7, 10, 15 or 25 percent of their Social Security payments withheld for taxes. Withholding the money can be easier than having to come up with the cash to pay your tax bill every quarter.

Watch Out for State Taxes

Social Security income might also be taxed at the state level. An analysis of state taxation of retirement benefits by the tax and accounting firm Wolters Kluwer found that 14 states tax Social Security payments for some retirees in 2014, including Colorado, Connecticut, Iowa, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, New Jersey, North Dakota, Rhode Island, Vermont and West Virginia.