Social Security Is Taxable? How to Minimize Taxes

Many retirees are surprised to learn that Social Security may be subject to taxation. Here are four strategies to help minimize taxes when you're receiving benefits.

For many retirees, Social Security is a crucial component of their income strategy, and you can expect to pay taxes on at least some of your benefits—especially if you receive additional revenue from other sources. The taxable amount depends on your combined income, which is your adjusted gross income (AGI) plus earnings from nontaxable interest and half of your Social Security benefits—and your spouse's if filing jointly—for the year. (Your AGI includes wages, interest, investments, and distributions from traditional 401(k) plans and traditional IRAs, minus certain adjustments to income.)

Unless your combined income for 2024 is less than $25,000 (less than $32,000 for married couples filing jointly), a percentage of your Social Security payments will be subject to income tax. Generally, for combined incomes between $25,000 and $34,000 ($32,000 and $44,000 for joint filers), up to 50% of your Social Security benefits may be taxed as ordinary income, and if your combined income exceeds those thresholds, up to 85% is taxable. Beware that your tax obligation could be higher if you live in one of the 10 states that tax Social Security.1

That said, these thresholds, which are not adjusted for inflation, will be too low for many to avoid taxation. Instead of concentrating on what you can do to avoid your Social Security benefits from being taxed, it might make more sense to focus on managing your overall tax liability. Here are four tax-smart strategies to consider.

1. Delay claiming your Social Security benefits

If you need to claim Social Security benefits before you reach your full retirement age, you could reduce your benefit by continuing to work, including part time or for yourself. As long as you draw a salary, $1 in benefits will be deducted for every $2 you earn above the annual limit—which is $22,320 for 2024—until the year you reach full retirement age, when the reduction falls to $1 for every $3 above the higher limit of $59,520.

Take note that this reduction is only temporary. The month you reach full retirement age, your payments will be recalculated because the Social Security Administration will credit back the deducted amount due to any excess earnings.

A better approach would be to delay taking Social Security if you don't need the extra funds. For each year you delay once you reach retirement age until age 70, you'll get an 8% bump on your payments, allowing you to rely less on other income sources when you start collecting. In the meantime, you can tap other accounts if you do need cash. Again, before postponing your Social Security, assess your personal circumstances to ensure you'll have the funds to live comfortably. 

2. Consider a Roth conversion

Once you reach age 73, you must take required minimum distributions (RMDs) annually from your tax-deferred accounts, including traditional IRAs and 401(k)s, which are taxed as ordinary income. Roth IRAs and Roth 401(k)s, on the other hand, do not have RMDs, and you won't pay taxes on withdrawals as long as you're age 59½ or older and you've had the account for at least five years.

Converting to a Roth could help minimize your tax liability, especially if you think you'll be in a higher tax bracket during retirement. You can open a Roth at any time, but be aware that you'll pay income tax on the converted funds upfront. Consult a tax professional and your wealth advisor to ensure this strategy fits your financial goals.

3. Manage your investment income wisely

Most investments generate taxable income in the form of interest, dividends, or capital gains. With careful planning, you can employ a few strategies to lessen your taxes. For example, your retirement can be a good time to rebalance and reallocate your portfolio to align with changes to your risk tolerance and timeline. Shifting some of your assets to tax-efficient or tax-free investments, such as municipal bonds, tax-exempt mutual funds, or tax-exempt exchange-traded funds, can offer continued growth without increasing taxable income. Take note that although municipal bonds are generally exempt from federal and state income taxes, the IRS includes interest from these bonds to calculate your combined income.

If you need to sell investments, focus on assets that you've held for at least one year so you'll pay the lower long-term capital gains tax rate of 0%, 15%, or 20%—depending on your income level. You can also potentially minimize taxes on investment income through tax-loss harvesting, where you offset capital gains by selling an underperforming asset. 

4. Maximize your charitable contributions

If you do a Roth conversion or find yourself selling appreciated assets when you rebalance your portfolio, you may be able to offset taxes with a charitable contribution. Individuals age 70½ and older can also use a qualified charitable contribution (QCD) to satisfy all or part of their annual RMDs.

Unlike RMDs, QCDs don't count toward your AGI, which means the contributions aren't tax deductible either. However, each individual can use a QCD to donate up to $105,000 tax-free to a qualified charity in 2024. (The annual QCD limit is indexed for inflation). You can also use up to $53,000 of a QCD to make a one-time donation to a Charitable Remainder Trust (CRT) or Charitable Gift Annuity (CGA).

The bottom line

For most retirees, Social Security taxes are inevitable, but understanding how your benefits impact your overall retirement income can help you consider strategies for minimizing your overall tax bill. Take care not to hinder potential growth opportunities just to save on taxes, and work with your wealth advisor to help make sure your retirement income stays on track.

1For 2024, Colorado, Connecticut, Kansas, Minnesota, Montana, New Mexico, Rhode Island, Utah, Vermont, and West Virginia tax Social Security benefits.

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

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 59½ are subject to an early withdrawal penalty. 

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.

Interest income on individual municipal bonds may not be tax-exempt, depending on the bond issuer, the type of bond, or your state of residence. Interest income on bonds issued by U.S. states, cities, counties, their enterprises, and U.S territories is generally federal-tax-exempt, and state-tax-exempt for residents of the state in which the issuer resides. In addition, municipal bond interest for bonds issued in U.S. territories is generally state-tax-exempt in all 50 states. Consult your tax advisor regarding your personal situation.

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Rebalancing does not protect against losses or guarantee that an investor's goal will be met. Rebalancing may cause investors to incur transaction costs and, when a non-retirement account is rebalanced, taxable events may be created that may affect your tax liability.

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Neither the tax-loss harvesting strategy, nor any discussion herein, is intended as tax advice and does not represent that any particular tax consequences will be obtained. Tax-loss harvesting involves certain risks including unintended tax implications. Investors should consult with their tax advisors and refer to the Internal Revenue Service (IRS) website at about the consequences of tax-loss harvesting.

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