Advanced Underwriting Consultants

Ask the Experts – October 3, 2014

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers. Here’s the question of the day.

Question: Are there ways to minimize income taxes on Social Security retirement benefits?

Answer: Taxpayers often try to minimize the amount of their Social Security retirement benefits subject to taxation with a number of strategies. Particularly, taxpayers can delay filing for Social Security and use their available retirement accounts or assets in the meantime.

For example, let’s say Maude plans to retire at age 62 and needs $40,000 per year on which to live. Also assume that Maude’s PIA is $2,000 per month, or $24,000 per year.

If Maude files at age 62, she will receive $18,000 per year from Social Security ($24,000 reduced by 25%), and presumably make up the extra $22,000 per year from her tax-deferred retirement accounts. Therefore, the $22,000 is added to her adjusted gross income, and her provisional income is $31,000 ($22,000 AGI + ½ of $18,000 Social Security benefits). Since Maude’s provisional income exceeds $25,000, she includes $3,000 of her Social Security benefits in her gross income (i.e. half of the excess of $31,000 provisional income over $25,000 base amount).

Let’s say Maude files at age 70 instead, where she would earn delayed retirement credits at 8% of her PIA per year. In this case, her benefit would be $31,680 per year, requiring her to take out only $8,320 per year from her personal retirement accounts. Her provisional income in this situation is $24,160 ($8,320 AGI + ½ of $31,680 Social Security benefits); therefore, no portion of her Social Security retirement benefits would be taxable.

We’ve purposefully used elementary examples to show how delaying Social Security while using other means until filing for benefits can help avoid taxes on one’s Social Security benefits. We did not take into account the myriad variables that should be taken into account when deciding whether to file for benefits early or later.

Additionally, there are other ways to reduce provisional income. For example,

  • Keep assets inside qualified retirement plans, since distributions from tax-qualified plans are generally added to AGI.
  • Liquidate tax-qualified retirement plans before filing for Social Security benefits.
  • Invest in after-tax retirement plans, such as Roth IRAs or designated Roth qualified accounts.

As usual, the benefits of reducing the amount of Social Security benefits should be weighed against the costs of each of these strategies.

Have a question for the professionals at AUC? Feel welcome to submit it by email. We may post your question and the answer as the question of the day.