3 Ways to Save Taxes While Collecting Social Security | The colorful fool

Social Security recipients can be in for an unwelcome surprise when they file their taxes.

One of the most effective ways to maximize your Social Security benefits in retirement is to keep your tax burden low. This requires careful financial planning and making the most of your various retirement accounts. But if you plan things well, you can significantly reduce taxes on your Social Security benefits and keep more for yourself.

Here are three ways to save on taxes while collecting Social Security.

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1. Relocating to a state that does not tax Social Security

There are 38 states that do not tax Social Security pension benefits, along with the District of Columbia.

However, if you live in one of the other 12 states, you may have to pay at least part of your Social Security tax. In some of these states, it’s possible to avoid paying taxes on Social Security entirely, but in many others it’s nearly impossible if you have even a modest Social Security check.

Of course, it’s not in most retirees’ interest to move to another state just for tax benefits. Without work tying you to one place, you probably chose your home for reasons other than money: your friends live there, the weather is nice, or the cost of living fits your budget.

Luckily, there are ways to reduce your Social Security tax without moving.

2. Limit withdrawals from traditional IRAs

Every single dollar you withdraw from your tax-deferred retirement accounts counts toward your adjusted gross income, the primary determinant of your tax bill.

The way taxes work on Social Security income is by combining your adjusted gross income, any non-taxable interest, and half of your Social Security income. If that number is below a certain threshold, $25,000 for individuals and $32,000 for couples, you don’t pay taxes on your Social Security benefits.

The amount over this limit and under $34,000 for individuals or $44,000 for couples, you will add 50% of your Social Security benefits to your taxable income. And for any amount above that, 85% of your benefits will be added to your taxable income.

In fact, every dollar you withdraw from your retirement account that takes you further above these thresholds will be taxed at 1.5x or 1.85x the tax rate until your total AGI exceeds the upper limit of the thresholds. So it makes sense to constrain your distributions as much as possible when you hit these thresholds. For this reason, minimizing your required minimum distributions is an effective tax planning strategy.

The best way around this is to use Roth accounts. Withdrawals from Roth accounts do not count towards your AGI. If you can make strategic Roth conversions before you collect Social Security, you can likely reduce your lifetime tax liability.

Another option is to use qualified charitable distributions (QCDs) from your IRA. QCDs come directly from your IRA to a nonprofit organization, so they don’t count towards your AGI. This is much more effective than the individual deduction for charitable donations.

3. Strategically sell assets in your brokerage account

When you sell a security in your brokerage account, you only pay tax on the gains.

If you can limit your gains to the point where you stay below the combined income threshold for Social Security taxation, you will face a very small tax bill. Not only do you pay 0% on your Social Security income, you probably also pay 0% tax on your capital gains.

There are a few strategies you can combine to keep your tax bill manageable. First, sell certain tax lots. A tax lot is a group of shares purchased in a single purchase at the same price. By using specific tax lots, you can have tight control over your capital gains. If you have tax lots that you bought at a high price, you can liquidate them with limited tax implications.

Of course, many of your assets are likely to have significant unrealized gains. In this case, it is best to sell these lots together with lots where you have lost money. The losses will offset the gains. Or, if you need to withdraw money from your retirement account, you can offset up to $3,000 of regular income against capital losses on your taxable investments.

Better planning leads to better results

If you’re planning to keep your taxes low, you’re probably doing better than simply withdrawing from your accounts as needed and passively accepting your April tax bill. Even if you can’t completely eliminate taxes on your Social Security income, these strategies should help you reduce the tax impact on your budget.

Source : www.fool.com

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