How to Pay ZERO TAXES on Social Security | 6 Simple Strategies

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"It's crucial to understand how different income sources can impact the taxation of your Social Security benefits."

Unlock the secrets to reducing your tax burden on Social Security benefits! Nearly half of all recipients now find themselves taxed on these crucial benefits, and the number is only climbing. On today's episode of The Limitless Retirement Podcast, our host Danny Gudorf explains why this is happening and provides actionable strategies to help you manage it. Learn how the unchanged income thresholds from the Reagan era have trapped more retirees in taxable brackets and discover how mandatory withdrawals from tax-deferred accounts at age 73 can complicate your financial picture even further.

Danny breaks down the IRS's formula for determining whether your Social Security benefits are taxable and explains the differences in thresholds for single filers versus married couples filing jointly. This episode is packed with essential information to help you optimize your retirement planning and minimize taxes on your hard-earned benefits. Tune in to gain the knowledge you need for a financially savvy retirement!

Key Topics:

  • History and Current State of Social Security Benefits Taxation (00:37)
  • Social Security Taxation Thresholds (05:54)
  • Real-Life Examples of Varying Social Security Taxation (07:32)
  • How to Avoid Paying Taxes on Social Security Benefits (11:37)
  • Wrap-Up (19:06)

As a retiree, you've worked hard for your Social Security benefits. However, you might be surprised to learn that these benefits could be subject to taxation. In fact, the number of retirees paying taxes on their Social Security has reached an all-time high. Let's dive into this crucial topic and explore strategies to keep more of your hard-earned benefits.

Key Takeaways:

  • The percentage of retirees paying taxes on Social Security benefits is approaching 50% and rising.
  • Understanding the "provisional income" formula is crucial for managing Social Security benefit taxation.
  • Strategies like delaying benefits, strategic withdrawals, and Roth conversions can help minimize taxes.
  • Careful planning before and during retirement can significantly reduce or eliminate taxes on Social Security income.

The Rising Tide of Social Security Taxation

For nearly five decades after its inception, Social Security benefits were tax-free. However, this changed in 1984 when the Reagan administration introduced the first tax on these benefits. Initially, it was estimated that only about 10% of recipients would be affected. Fast forward to 2022, and the landscape has changed dramatically:

  • A staggering 48% of recipients now pay taxes on a portion of their Social Security benefits.
  • In 2022 alone, nearly $50 billion in taxes were paid on Social Security benefits.
  • This year, the percentage of recipients paying taxes is expected to surpass the 50% mark.

Why Are More Retirees Paying Taxes on Social Security?

The primary reason for this increase is simple: while Social Security payments and federal income tax brackets have adjusted upwards to account for inflation over the past 40 years, the income thresholds that determine whether Social Security benefits are taxable have remained unchanged. This lack of adjustment has led to an increasing number of retirees falling into the tax bracket where their Social Security becomes taxable.

Understanding the Taxation Formula

To determine if your Social Security benefits are taxable, the IRS uses a formula called "provisional income" or "combined income." Here's how it works:

  1. Start with your taxable income (including W-2 income, investment income, dividends, rental income, and pension income).
  2. Add any tax-exempt interest (such as interest from municipal bonds).
  3. Include any excluded foreign income.
  4. Add 50% of your Social Security benefit.

The resulting figure is your provisional income. This number is then compared against certain thresholds to determine what percentage of your Social Security benefits will be subject to taxation.

Taxation Thresholds

For Single Filers:

  • Provisional income less than $25,000: No taxes on benefits
  • Provisional income between $25,000 and $34,000: Up to 50% of benefits may be taxed
  • Provisional income exceeding $34,000: Up to 85% of benefits may be taxed

For Married Couples Filing Jointly:

  • Provisional income less than $32,000: No taxes on benefits
  • Provisional income between $32,000 and $44,000: Up to 50% of benefits may be taxed
  • Provisional income exceeding $44,000: Up to 85% of benefits may be taxed

It's important to note that these percentages represent the portion of your benefits that may be subject to taxation, not the actual tax rate applied to your benefits.

Real-Life Examples

To better understand how this works in practice, let's consider a few scenarios:

Example 1: Bill and Mary

Bill and Mary receive a combined Social Security benefit of $60,000 per year with no other income sources. Their provisional income would be 50% of $60,000, which is $30,000. Since this is below the $32,000 threshold for married couples filing jointly, none of their Social Security benefits would be taxed.

Example 2: Bill and Mary with RMDs

Now, let's say Bill and Mary are required to take $30,000 in Required Minimum Distributions (RMDs) from their tax-deferred retirement accounts. This changes their tax situation significantly:

  • Their provisional income increases to $60,000 ($30,000 from RMDs + $30,000 from 50% of Social Security)
  • This puts them above the $44,000 threshold, meaning up to 85% of their benefits could be taxable
  • Nearly $20,000 of their Social Security income now becomes subject to taxation

Example 3: Varying Income Sources

Consider a couple with $30,000 in Social Security benefits and $30,000 in other taxable income (like pensions or RMDs). Despite having the same total income as Bill and Mary in Example 2 ($60,000), a higher proportion of their Social Security benefits would be subject to taxation - about $7,000 in this case.

This discrepancy highlights an important point: the source of your retirement income can significantly impact your tax liability.

Strategies to Reduce or Eliminate Taxes on Social Security Benefits

Now that we understand how Social Security benefits are taxed, let's explore strategies to minimize or eliminate these taxes:

1. Delay Claiming Social Security Benefits

By waiting to claim your benefits (ideally until age 70), you create a window of opportunity to draw down your taxable and tax-deferred accounts before Social Security income kicks in. This strategy can help reduce your overall tax burden in retirement.

2. Strategic Early Withdrawals

Even if you don't need the money for living expenses, consider withdrawing funds from your traditional IRAs or 401(k)s before you start receiving Social Security. This can help reduce your RMDs later, potentially keeping you in a lower tax bracket.

3. Optimize Your Investment Strategy

Focus on growth-oriented assets with lower dividend payouts in your taxable accounts. This approach can help keep your taxable income lower. Additionally, consider overweighting international stock holdings in your taxable accounts to take advantage of foreign tax credits.

4. Utilize Tax Loss Harvesting

In taxable accounts, you can sell investments at a loss to offset capital gains. This strategy can potentially reduce your overall taxable income, which in turn may lower the amount of your Social Security benefit subject to taxation.

5. Execute Roth Conversions Before Claiming Social Security

The years between retirement and when you start claiming Social Security (often referred to as "gap years") present an excellent opportunity for Roth conversions. By converting funds from traditional IRAs or 401(k)s to Roth accounts during these lower-income years, you can potentially minimize the tax impact on your future Social Security benefits.

Conclusion: Planning Is Key

While the taxation of Social Security benefits is becoming increasingly common, careful planning can help you keep more of your hard-earned money. By understanding the taxation formula and implementing strategic moves before and during retirement, you can potentially reduce or even eliminate taxes on your Social Security income.

Remember, everyone's financial situation is unique. It's always a good idea to consult with a financial advisor or tax professional to determine the best strategies for your specific circumstances. With the right approach, you can navigate the complexities of Social Security taxation and enjoy a more financially secure retirement.

*This blog post is based on the insights shared by Danny Gudorf of Gudorf Financial Group in an episode of the Limitless Retirement Podcast. For personalized advice tailored to your unique circumstances, always consult a financial, legal, or tax professional.*

Transcript: Prefer to Read — Click to Open

Danny (00:05.454)

Welcome to the Limitless Retirement Podcast. My name is Danny Goodorf, the owner of Goodorf Financial Group. Whether retirement is on your horizon or you’ve already made the leap, this podcast tackles your most important questions in retirement. Every episode, I’m here to share valuable tips and strategies to help you succeed in retirement. So let’s go ahead and get started with today’s show.

The number of people paying taxes on their Social Security benefits is reaching an all -time high, and the situation is only getting worse. In this video, we’ll look at the formula for taxing Social Security benefits. We’ll also explore why the taxes are increasing, and we’ll discuss ways to reduce or eliminate these taxes. For nearly five decades,

following the inception of Social Security, Social Security benefits were exempt from taxation. However, in 1984, during the Reagan administration, the first tax on Social Security benefits was implemented. It was estimated that approximately 10 % of Social Security recipients would be subject to this tax. Now, if we fast forward to 2022,

The landscape has changed and it has changed dramatically. A staggering 48 % of recipients pay taxes on a portion of their Social Security benefits. This amounted to nearly $50 billion of taxes paid on Social Security. This year, that percentage is expected to surpass the 50 % mark. Over the past 40 years, Social Security payments

and federal income tax brackets have both adjusted upwards. This was to account for the raising inflation. However, the income thresholds that determine whether Social Security benefits are subject to taxation have remained unchanged for four decades. This lack of adjustment has led to an ever -increasing number of retirees

Danny (02:33.71)

falling in to the tax bracket where their Social Security becomes taxable. Avoiding taxes on your Social Security benefits is possible, but it becomes increasingly challenging once you reach the age of 73. At that point, you must begin taking your required minimum distributions, otherwise known as RMDs. These distributions come from your 401ks,

your IRAs and your other tax deferred accounts. These mandatory withdrawals can push your income into a higher tax bracket, potentially subjecting a larger portion of your Social Security benefits to taxation. One small positive thing to note is that most states do not tax Social Security benefits. In fact, 37 states

have chosen not to tax these benefits. However, there are a few states that do impose taxes on your Social Security income. If you’re able to navigate the federal tax on your Social Security, then you can be successful and it should also take care of any state tax obligations. So,

Let’s explore how your Social Security benefits are taxed in more detail. The IRS uses a formula called provisional income, or otherwise known as combined income, to decide if your benefits will be taxed. Here’s how it works. What you do is you take your taxable income, which includes things like W -2, investment income, dividend income,

could be rental income and any pension income that you have along with any other taxable income sources. Then you add in your tax -exempt interest, such as interest from municipal bonds, which is popular among high -income retirees. Then you include any excluded foreign income. In some cases, if you have earned income

Danny (04:59.15)

in a foreign country, you might be able to exclude it from your taxes. However, for the purpose of the provisional income formula, it needs to be added back in. Then what we do is we take 50 % of your Social Security benefit and we add it to the sum of the above items. This resulting figure is your provisional income or combined income. This number

is then compared against certain thresholds to determine what percentage of your Social Security benefits will be subject to taxation. It’s important to note that this is not the actual tax amount, but rather the portion of your benefits that will be included in your taxable income. Let’s go through a breakdown of these different thresholds. First,

we’ll start with single filers. If your provisional income is less than 25 ,000, none of your benefits are taxed. The next threshold is if your provisional income is between 25 ,000 and 34 ,000, up to 50 % of your benefit is subject to taxation. If your provisional income exceeds

34 ,000, up to 85 % of your benefits is subject to tax. Now, let’s jump into what that looks like for married couples who are filing jointly. The brackets will shift up a little bit when it comes to married couples. If your provisional income is less than 32 ,000, none of your benefits are subject to tax. If your provisional income is 32 ,000 to 34 ,000,

then up to 50 % of those benefits can be subject to tax. And if your provisional income exceeds $44 ,000 per year as a married couple filing jointly, then up to 85 % of your benefit is subject to tax. And I always like to remind clients that that’s just the amount that’s subject to some taxation. That doesn’t mean

Danny (07:26.926)

you’re gonna be taxed 50 % or 85 % on your social security benefits. So to help clarify that a little bit, let’s consider a real life example to illustrate how this works. So suppose in our example couple, Bill and Mary, they have a combined social security benefit of 60 ,000 per year with no other income sources. To calculate their provisional income,

they would take 50 % of their $60 ,000 benefit, which equals $30 ,000. Since their provisional income is below the $32 ,000 threshold for married couples filing jointly, none of their Social Security benefits would be subject to taxation. Pretty straightforward, right? Now, let’s introduce a twist.

Imagine that Bill and Mary are required to take $30 ,000 in required minimum distributions or RMDs from their tax deferred retirement accounts. This 30 ,000 would be considered ordinary income. However, instead of simply just paying the taxes on the 30 ,000 of RMDs, they would now owe taxes

on 50 ,000 because nearly 20 ,000 of their Social Security income now becomes subject to taxation due to this increased income from their RMDs. To illustrate this further, let’s use a calculator. I’ll link the calculator website in the show notes below for you to be able to experiment and test a couple different strategies on your own.

In this calculator, we’ll input Bill and Mary’s situation. Married status, filing jointly. Social Security benefits of 60 ,000. Other income, zero, initially. With just the 60 ,000 in Social Security benefits and no other income, their tax liability would be zero. However, when we add in the $30 ,000 from the RMDs to their income,

Danny (09:54.926)

the calculator shows that nearly $20 ,000 of their Social Security benefits would now become taxable. Now, let’s consider a different scenario. Suppose a couple had 30 ,000 in Social Security benefits and 30 ,000 in other taxable income, such as pensions or RMDs. In this case, even though they had the same amount of total income as Bill and Mary,

which is 60 ,000, a higher proportion of their social security benefits would be subject to taxation. The calculator reveals that almost 7 ,000 of their social security benefits would be taxable. This discrepancy highlights what I believe is an archaic formula. Even though both couples have the same total income, the couple

with a higher percentage of their income coming from sources other than Social Security face a higher tax burden on their Social Security benefits. It’s crucial to understand how different income sources can impact the taxation of your Social Security benefits. I encourage you to play around with the calculator using the link provided in the show notes. Experiment.

with different scenarios to gain a better understanding of how your benefits might be taxed and how various changes can affect the taxation of your Social Security income. So how can you avoid paying taxes on your Social Security benefits? The answer lies in careful planning. If you’re younger and watching this video, the easiest way to plan ahead

is prioritizing contributions to Roth IRAs or Roth 401Ks. The rules surrounding Roth 401Ks continue to improve in the favor of taxpayers, making them a very attractive option for tax -free income in retirement. However, if you’re watching this like most people watching this video,

Danny (12:19.918)

you’re likely already have a significant amount of money in tax -deferred accounts like traditional 401ks and traditional IRAs. You’ll eventually need to take distributions from these accounts either to cover your living expenses or to satisfy required minimum distributions. When you do, the additional ordinary income can trigger that higher tax

on your Social Security benefits. So I’m gonna walk you through a few strategies to help reduce the tax burden on your Social Security income and lower your overall tax liability. All right, strategy number one is delay claiming Social Security benefits. The longer you wait to start to receive benefits, the more time you have to draw down

your taxable and your tax deferred accounts before your social security income kicks in. For many people, it makes sense to delay claiming benefits until age 70, even if they retire as early as 62. This eight -year window allows for strategic withdrawals from other accounts. Strategy number two, withdraw money

from your traditional IRAs or your 401ks early. Do this if you don’t need the money to live on. And even if you aren’t planning a Roth conversion, consider moving the money from your tax -deferred account to your taxable account. While it might seem counterintuitive, a taxable account can often be more tax -advantaged

than your traditional IRA or 401k. Obviously, this depends on certain situations. All right, strategy number three, reduce dividend and interest payments in taxable accounts. Retirees often hold a significant portion of their portfolio in bonds and dividend paying stocks, which generate income. However, in a taxable account,

Danny (14:42.19)

and may be more beneficial to focus on higher growing assets with lower dividends and lower payouts. This approach will keep your taxable income lower. Strategy number four, taxable accounts often have too many foreign stocks. A diverse portfolio usually puts 20 to 30 % in them using ETFs or mutual funds.

Many people are unaware that there’s often a tax rebate available on international funds because the companies have already paid tax from their country of origin. To avoid double taxation, you’ll receive a rebate on the foreign taxes paid. If these holdings are in a taxable account, the rebate comes through as a tax deduction. However,

If they’re in a qualified account, there’s no benefit. To optimize this strategy, consider overweighting your international stock holdings in your taxable account while underweighting them in your qualified accounts. Next, you want to consider utilizing tax loss harvesting. In a taxable account, you can sell investments at a loss to offset any capital gains you might have.

Now, there are several rules surrounding tax loss harvesting that warrant a separate video. But here’s a quick example. If you have a capital loss, it can offset ordinary income up to $3 ,000. If you have no capital gains to offset, a $30 ,000 capital loss can offset 3 ,000 of ordinary income.

potentially reducing your income for Social Security benefit taxation purposes. The remaining $27 ,000 in losses can now be carried forward to the next year. If you don’t have any capital losses the following year, you can apply another $3 ,000 against your ordinary income and then roll the remaining $24 ,000 to the subsequent year.

Danny (17:09.006)

and you can do this year after year. Tax loss harvesting can be an effective way to reduce your taxable income in your portfolio. All right, the last strategy that we want to talk about is executing Roth conversions before claiming Social Security. This is by far one of the biggest tax strategies that we have available to us. We have another entire video dedicated to this topic.

which you can watch at another time. But leading into retirement between age 62, all the way up to when you have to start taking required minimum distributions at age 73, these give you a planning window. We call these your gap years. And you can do Roth conversions in your gap years, which means you’re converting funds

from a traditional IRA or 401k to a Roth account before your Social Security benefit begins. This can help minimize the tax impact on your Social Security. By delaying Social Security, it provides a longer window for you to be able to perform these conversions in years when your income is lower. While Roth conversions

can still be done after you start receiving Social Security, the additional benefit or the additional ordinary income from the conversion may push more of your taxable Social Security benefits into that taxable range. So doing Roth conversions in those gap years can provide a lot of relief when it comes to your taxation of Social Security.

So that concludes today’s videos. In the show notes, you’ll find a link to the calculator. It lets you explore how much of your Social Security benefit will be taxed. It also shows how much other income affects that tax. I encourage you to play around with the calculator to gain a better understanding of how your specific Social Security benefit will be taxed.

Danny (19:34.606)

Thank you for watching. I hope you found this information useful. It can help you navigate the complexities of Social Security taxes. Remember, with careful planning and the right strategy, you can minimize or even eliminate taxes on your hard -earned Social Security income. Don’t forget to like and share and subscribe. Stay tuned for updated future content.

that’s designed to help you achieve a worry -free retirement. Have a great day. Thank you for listening to another episode of the Limitless Retirement Podcast. If you want to see how Goodorf Financial Group can help you get the most out of your money, go to goodorffinancial .com forward slash get started. This is where you can schedule a 20 minute call to see how our firm

can help prepare a free retirement assessment. Please remember, nothing we discuss on this podcast is intended to serve as advice. You should always consult a financial, legal, or tax professional that is familiar with your unique circumstances before making any financial decisions.

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