How to Minimize Social Security Taxes

Understanding how Social Security works is important. Lane V. Erickson/Shutterstock

You’ve been contributing to Social Security for decades, and now you find out you owe taxes. You’re not alone. Approximately 40 percent of people who receive Social Security pay taxes on it. Indeed, depending on your income, almost 85 percent of your Social Security benefits might be taxable.

When many people hear this, they have a rude awakening. You’re not told when you were younger that your benefits would be taxed. But how did this happen and how much is taxable? What do you do to minimize it.

What Percent of Social Security Is Taxable?

Before 1984, Social Security was tax-free. It’s now taxable to recipients who meet a certain income threshold. So, if you’re working part-time, you might fall into this trap. You'll also be stuck if you receive income from a 401(k).

Taxable Social Security income for single filers and the percentage they'll be taxed:

• Below $25,000—no tax
• $25,000 to $34,000—up to 50 percent
• More than $34,000—up to 85 percent

Taxable Social Security income for married filing jointly and percentage they’ll be taxed:

• Below $32,000—no tax
• $32,000 to $44,000—up to 50 percent
• More than $44,000—up to 85 percent

Those who promote taxes on the rich can’t claim this for Social Security taxes. This tax is on the middle class, and these levels haven’t been updated in years.

Potential Ways to Minimize Social Security Taxes

There’s no way to avoid the Social Security tax, but ways to minimize it exist. One is to not take it in the first place. If your income is over the threshold and you can do it, don’t retire early. Waiting not only decreases the amount of taxes you pay but it also increases your benefits.

There are other ways to minimize Social Security taxes.

1) Convert Investment Income Into an Annuity

Some people don’t like or feel uncomfortable with annuities, but they have a purpose.

Money growing inside an annuity has the interest reinvested back into an annuity. You’re not taxed until you start receiving payments.

For example, if you had a $200,000 CD earning 3 percent interest, your CD would generate $6,000 a year. That is counted as provisional income and applied to your Social Security taxes.

But if you put that same $200,000 into an annuity, the money will be reinvested and yield zero interest when computing provisional income.

2) Reduce Business Income

Minimize any income you receive from a partnership or other business.

Increase your deduction or expenses to reduce any K-1 or pass-through income.

Although you might not be able to sustain this every year, combine your deductions and expenses into alternating years. That way, you'll only be hit with the Social Security tax every other year.

3) Roth IRA for Non-Taxed Income

Withdrawals from a Roth individual retirement account (IRA) or a Roth 401(k) aren’t subject to taxation. The taxes were already applied when you made the contributions. One hundred percent of your withdrawals are tax-free.

Roth IRA income doesn’t count toward the “combined income” that affects taxes on your Social Security benefits.

But you must have had the Roth IRA for five years and be over the age of 59½ to withdraw the money tax-free.

You can open a Roth at any time. If you still have earned income, you can contribute. Income is defined as self-employment or employment wages. You cannot invest income from investments or your Social Security into a Roth IRA.

Another option is to convert a tax-deferred retirement account to a Roth IRA. However, this will result in a large tax liability. You can take a large hit at one time or multiple hits from both the taxes due on the tax-deferred retirement account and the Social Security taxes.

If you want to swallow hard, place the money in the Roth IRA and the distribution of those proceeds won’t affect your Social Security tax threshold.

4) Required Minimum Distribution Taxes

A required minimum distribution (RMD) can increase your tax liability. But, a qualified charitable distribution (QCD) may help lower your tax liability and Social Security taxes.

A QCD can reduce your adjusted gross income, lowering your Social Security taxes.

The minimum age to make a QCD is 70½. The QCD isn’t deductible; it will merely lower your adjusted gross income.

To take advantage of this, you must have the payment transferred from your IRA to the charity. You can’t have the money dispersed to you and then donated; it must go directly to the charity.

You also cannot give to a donor-advised fund or a private foundation. The payment must go directly to a 501c (3) charity registered with the IRS.

Tax-Free Social Security Gone

While tax-free Social Security is gone, some ways to minimize your tax liability exist.

If you can make some changes regarding income, then shooting for a tax-free Social Security could happen.

Others with larger incomes may find that overhauling their lifestyle isn’t possible.

Talk to an accountant or tax attorney about your circumstances.

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