Senior Healthcare Advisors Blog
If you are approaching retirement and think your Social Security benefit always comes tax-free, you're mistaken. Today, 56% of Americans pay taxes on their Social Security benefit—up from 10% of Social Security recipients in 1984 when the federal government first began taxing the Social Security benefit.
These taxes can really take a bite out of your enjoyment of retirement, so it's important to learn now how Social Security income is taxed and explore ways to help reduce that tax burden.
Unless your combined household income in retirement is less than $25,000, then up to 85% of the Social Security benefit you receive each year could be subject to tax. Regardless of your situation, never more than 85% of your Social Security income will be subject to tax. However, 100% of your withdrawals from traditional IRAs and traditional 401(k)s will likely be considered taxable income.
How Social Security Benefits are Taxed
In retirement, different kinds of income are taxed differently. For example, most interest on bank deposit accounts, such as CDs or checking and savings accounts, is taxed at the same federal income tax rate as the money you receive from paid work, known as earned income.
Distributions from traditional 401(k)s and IRAs are typically subject to the tax rates associated with your current marginal tax bracket. Other income—such as qualified withdrawals from a Roth IRA, a Roth 401(k), or health savings account (HSA)—are not subject to federal income taxation and do not factor into how your Social Security benefit is taxed.
When the total income calculated under the combined income formula for social security is more than the threshold ($34,000 for singles and $44,000 for couples), up to 85 cents of every Social Security income dollar will be taxed.
How Can You Reduce Taxes on Your Benefits?
Generally, unless you have a pre-retirement income over $100,000 a year, you may be able to take advantage of the following 2 strategies to help reduce taxes on your Social Security benefits:
Convert to a Roth - Consider a Roth IRA or Roth 401(k) conversion
Although not everyone can contribute to a Roth IRA or Roth 401(k) because of IRS-imposed income limits, you still may be able to benefit from a Roth IRA's tax-free growth potential and tax-free withdrawals by converting existing money from a traditional IRA or a workplace retirement savings account to a Roth IRA account. The process of converting some of your IRA or 401(k) to a Roth IRA account is known as a partial Roth conversion and it will help increase your after tax benefit.
You can choose to convert as much or as little as you want of your eligible traditional IRAs. This flexibility enables you to manage the tax cost of your conversion. A Roth IRA or Roth 401(k) can help you save on taxes in retirement. Not only are withdrawals potentially tax-free, they won't impact the taxation of your Social Security benefit. This is an important aspect of a Roth account that most people are not aware of.
2) Defer Your Benefits - Consider delaying your Social Security benefit claim
Even if you don't have a Roth account, there’s another way for individuals or couples to reduce their combined income in retirement ..... Delay claiming your Social Security benefit.
For every year you delay past your full retirement age (FRA), you get up to an 8% increase in your annual benefit. In general, many people benefit from waiting to age 70 to take payments. Others may need the income sooner and may lack the resources necessary to meet expenses during the delay period, or may not live long enough to reap the rewards of delaying their claim.
Let's take a look at the effect of taxes on a hypothetical married couple and how they can reduce their tax burden if they both delay claiming their Social Security benefit until each of them reaches age 70.
Their strategy is to reduce the amount they withdraw from their taxable IRAs over time and make up the difference in income by waiting until age 70 to claim Social Security. This has a big payoff for the couple because delaying their Social Security benefits until age 70, reduced the percentage of their Social Security income that gets taxed, from 85% to 50%.
Even better ..... Their retirement paycheck of nearly $68,000 per year remains about the same, but they pay 20% less in taxes and withdraw smaller amounts from their respective IRAs each year.
No matter how you slice it, paying attention to your finances and putting extra money in your pocket during your retirement years is a smart thing to do. However, having adequate finances isn't the only factor that leads to quality of life in your senior years.
Another important aspect to a happy retirement is your health. Many seniors need to accept that good health isn't always under their control.
That's why it's so important to have a solid health care plan, especially as you age. Routine visits to the doctor, pre-screening tests and overall preventative health care play an essential role in improving and maintaining your quality of life.
The right information at the right time could make all
the difference with your Medicare Plan choices.
Senior Healthcare Advisors is a leading resource throughout the country for Medicare knowledge and guidance. Our mission is to educate seniors about their options
and empower them to make the Medicare choices that are right for them.
Our licensed Medicare Specialists will work with you Free of Cost to put your Medicare and Part D prescription drug plans together for the lowest possible cost in your area .... Guaranteed! Additionally, we'll review your plan annually to ensure your getting the best possible coverage for the best price, year after year.
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