2 Ways to Avoid Paying Tax on Social Security Benefits
Social Security benefits can go a long way in helping you enjoy a more financially secure retirement. However, you can’t collect as much as you might think.
Your monthly checks are subject to federal and state taxes, and these taxes can dramatically reduce your benefits. If you’re going to depend on Social Security to pay your bills in retirement, taxes could wreak havoc on your financial plans.
Fortunately, there are ways to avoid taxes on your benefits. With the right strategy, you may be able to avoid paying them off completely. Here’s how.
1. Change to a different state
Whether you have to pay state taxes on your benefits depends on where you live. Social Security benefits count as retirement income and are subject to income tax, but not all states tax the income. Additionally, some states have an income tax but exclude Social Security benefits.
The good news is that most states don’t tax Social Security, and only 13 do. These 13 state that to do tax benefits include:
- New Mexico
- North Dakota
- Rhode Island
- West Virginia
If you live in one of these states, your benefits will be subject to state income tax. The exact amount you will pay will depend on your income as well as the individual laws of your state.
Moving to a more Social Security-friendly state could help save you money on taxes, but make sure you’ve done your research before you move. Some states may not tax Social Security, but they might have a higher cost of living, higher property or sales taxes, or other expenses that might end up costing you more than if you had stayed in. your current state.
2. Contribute to a Roth IRA
Social Security benefits are also subject to federal taxes, regardless of the state in which you live. Federal taxes on benefits are more difficult to avoid because they depend on your retirement income. However, there is a way to reduce or eliminate them: Keep most of your savings in a Roth IRA.
The IRS uses a figure called “combined income” to determine what percentage of your benefits will be subject to federal taxes. Your combined income is your adjusted gross income plus half of the annual amount of your social security benefits. So, for example, if you withdraw $ 40,000 per year from your 401 (k) and earn $ 20,000 per year from Social Security, your combined income would be $ 50,000 per year.
|Percentage of your benefits subject to federal taxes||Combined income for individuals||Combined income for married couples declaring jointly|
|0%||Less than $ 25,000 per year||Less than $ 32,000 per year|
|Up to 50%||$ 25,000 to $ 34,000 per year||$ 32,000 to $ 44,000 per year|
|Up to 85%||Over $ 34,000 per year||Over $ 44,000 per year|
The only way to stop paying federal taxes is if your combined income drops below $ 25,000 per year (or $ 32,000 per year for married couples who file jointly).
However, Roth IRA withdrawals do not count towards your combined income. So, for example, suppose you withdraw $ 40,000 per year from your Roth IRA and receive $ 20,000 per year from Social Security. In this case, your combined income is only $ 10,000 and your benefits would not be subject to federal tax.
Taxes may be inevitable, but they shouldn’t eat into your Social Security benefits. With these two strategies, you can lower your taxes and keep more of your money.