Social Security Is Taxable? How to Minimize Taxes

February 7, 2023
Many retirees are surprised to learn that, above a certain income threshold, Social Security can be subject to taxation. Here are strategies to consider.

For many retirees, Social Security benefits are a crucial component of their retirement income strategy. However, many Americans are surprised to learn some of that income can be taxed. If you’re receiving Social Security benefits or plan to start collecting them soon, make sure you understand how this income could be taxed.

When Social Security benefits are taxed

Generally, your Social Security benefits are taxed when your income is more than $25,000 per year, including income from investments held in retirement accounts like traditional 401(k)s and IRAs. If Social Security is your only source of income, you likely won't pay any tax on those payments. However, if you're receiving income from investments, a part-time job, or other sources, there's a good chance you’ll have to pay taxes on your Social Security income.

Regardless of your total income, the maximum taxable portion of your Social Security benefits won't exceed 85% under the current tax codes.

If your benefits are indeed subject to taxation, consider these three strategies to potentially reduce the tax implications:

  • Convert a traditional 401(k)/IRA to a Roth 401(k)/IRA
  • Leverage investments that provide nontaxable income
  • Delay taking Social Security benefits

Let's look at how to determine if your Social Security income will be taxed, plus a few ideas that might help reduce your taxable income in retirement.

How Social Security taxes are calculated

To calculate your taxable Social Security benefit, first determine your adjusted gross income (AGI), which is your total taxable income. This might include money you make from:

  • Employment
  • Distributions from traditional 401(k) plans and traditional IRAs
  • Taxable income from investments, such as stock dividends and interest from taxable accounts

Second, subtract any tax deductions to determine your AGI.

Finally, add two components to that AGI:

  • You nontaxable interest
  • Half the amount of your Social Security benefit

This total is your "combined income." If your combined income is more than $34,000 for singles or $44,000 for couples, up to 85% of your Social Security income may be taxed. 

3 ideas that might help reduce your taxable income in retirement

Social Security income is taxed at a lower rate than income from other sources, such as traditional retirement accounts. So, you may want to consider the following strategies to help potentially reduce your income from those accounts. That way a greater portion of your income is derived from Social Security.

1. Convert to a Roth IRA

Withdrawals on Roth IRAs and Roth 401(k)s aren't subject to taxation because taxes were taken when the contributions were made. If your money is in a traditional IRA or 401(k), you already received a tax advantage in the form of an income tax deduction when you deposited the money, so 100% of those withdrawals will be taxed as income. Income from a Roth account doesn't count toward the "combined income" that will affect taxes on your Social Security benefits. But remember, you must have a Roth account open for five years and be over the age of 59.5 before you can withdraw the money tax-free. You can open a Roth at any time, and you can continue to contribute to a Roth in retirement as long as you have earned income. (Income must be from employment or self-employment wages. Income from investments or Social Security don't qualify as income for the purposes of contributing to an IRA.)

Be aware that converting from a tax-deferred retirement account to a Roth IRA means you’ll pay income tax on that money, which can be substantial, but after that first tax bill, your distributions will be tax free and won't count toward your income calculation. Also, a provision in the Tax Cut and Jobs Act declared that a Roth conversion can't be "recharacterized," which means it can’t be transferred back to a traditional IRA if you change your mind about the conversion.

2. Consider shifting income investments

Some investments generate taxable income, while others are nontaxable. For example, the interest income from many bonds is subject to tax. Dividends and interest from savings accounts or other investments also count as taxable income. Interest income on municipal bonds generally is exempt from federal and state income taxes with a few exceptions: Any capital gains distributed may be taxable; income received from muni investments may be subject to the Alternative Minimum Tax for some investors; and interest income from muni bonds is added back as part of your modified adjusted gross income when computing potential tax due on Social Security benefits on modified income of more than $25,000 for individual filers, $32,000 for joint filers.

With a strategy of reallocating investments to include nontaxable income, investors can accept retirement payments that do not count as income, which means they won't add to the income that can trigger taxes on Social Security benefits. By shifting some of your assets to those that favor the types of income that are shielded from taxation, you can still plan for the same amount of retirement income with potentially lower taxes on your Social Security.

3. Delay claiming your Social Security benefits

If you have outside income and other investments, consider being more aggressive on drawing down those assets early on while delaying taking Social Security. You’ll get a Social Security bump the longer you wait—8% per year until age 70. By then, if you've drawn down other assets (which are likely taxed at a higher rate), there might be fewer of those assets left to tax, which can potentially lower the amount of your Social Security benefits subject to taxation.

Before choosing to delay your Social Security benefits, assess your expected income from all sources and compare them to your expected expenses. This can help ensure you'll have the funds to live comfortably.

The bottom line

Social Security taxes may come as a surprise to many retirees, but as you learned, there are several effective ways to potentially reduce these taxes. Remember to examine how all your income sources might impact your tax rate, and then consider your available strategies for getting the most out of your retirement income.

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The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security's tax-exempt status (federal and in-state) is obtained from third parties, and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

Roth IRA conversions require a 5-year holding period before earnings can be withdrawn tax free and subsequent conversions will require their own 5-year holding period. In addition, earnings distributions prior to age 59 1/2 are subject to an early withdrawal penalty.

The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Investing involves risk, including loss of principal.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.