Mailbag: Reducing Taxes By Choosing When To File For Social Security

answers to social security questions

A reader wants to know when he should file for Social Security in order to pay the least amount of retirement tax.

QUESTION:

Should I retire at 66 years old and use my IRA for income before taking Social Security? My retirement income will come from my pension, RMD, Social Security and rental. I am a conservative investor. My RMD annual income at 4% will be the biggest piece of the pie. My gross retirement income will be more than my taxable income while employed. I don’t want to pay extra taxes. What should I do?

ANSWER:

I don’t blame you for not wanting pay extra taxes! When viewed through a long term perspective, taxes in retirement may be one of your greatest single expenses. Although your tax advisor is the best resource for recommendations on an overall tax reduction plan, there is one strategy that is really easy and often overlooked…it could be as simple as structuring your income properly.

As you’re probably aware, between 0% and 85% of your Social Security benefits will be added to your taxable income. In order to determine how much of your Social Security benefits will be taxable, you first have to calculate “provisional income” – a measurement of income used specifically for this purpose. Provisional income can be roughly calculated as your total income from taxable sources, plus any tax exempt interest (such as interest from tax free bonds), plus any excluded foreign income, plus 50% of your Social Security benefits.

If you can structure your income in a manner that reduces your provisional income, you should see a corresponding reduction to the amount of your Social Security that is counted as taxable income.

For example, lets say you need a total of $6,000 in monthly income and your SS benefit at your full retirement age is $2,000. (we’ll assume your full retirement age is 66)

Income Strategy #1) Take your $2,000 SS benefit and get the remaining $4,000 from your other sources.

Income Strategy #2) Delay your SS benefit and take the total $6,000 income need from your other sources. At age 70, you file for your SS benefit of $2,640. The remaining $3,360 would come from your other sources.

Remember that only half of your Social Security income is included on your “provisional income” calculation.  By increasing the amount of income from Social Security, and a corresponding reduction of income from other sources, the amount of total taxable income should decline.

Needless to say, this is a very simplistic overview. One things for sure. Your situation IS different. Before you build your own strategy, get a super competent financial planner and tax advisor to help walk you through this. If you want to do more research before you start, I’ve written an article that covers this topic at https://socialsecurityintelligence.com/retirement-tax/

Hope this helps!