Actionable Strategies and Money-Saving Tips
Now that you understand the rules, you can see that the key to minimizing taxes on your benefits is to manage your combined income. The lower you can keep your combined income, the less likely your benefits will be taxed. Here are several practical tax strategies you can use.
Strategy 1: Strategically Manage Retirement Account Withdrawals
For most retirees, the largest source of controllable income comes from retirement accounts. How you pull money from these accounts has a huge impact on your AGI.
- Traditional IRAs and 401(k)s: Every dollar you withdraw from these accounts is treated as ordinary income and fully counts toward your AGI. A large withdrawal in a single year can easily push your combined income over the taxability thresholds. Instead of taking a large lump sum, consider taking smaller, regular withdrawals sufficient to cover your expenses.
- Roth IRAs and Roth 401(k)s: This is where careful planning pays off. Qualified withdrawals from Roth accounts are completely tax-free. They do not count toward your AGI and therefore have zero impact on your combined income calculation. If you have both traditional and Roth accounts, pulling from your Roth account in a given year can be a powerful way to get cash without increasing the tax on your Social Security.
Action Step: Review your retirement savings. If you need extra money for a large purchase, consider pulling from a Roth IRA if you have one, instead of a traditional IRA, to keep your combined income low for the year.
Strategy 2: Use Qualified Charitable Distributions (QCDs)
If you are age 70½ or older and are charitably inclined, the QCD is one of the most effective tax-saving tools available. A QCD allows you to donate money directly from your traditional IRA to a qualified charity.
Here’s why it’s so powerful: The amount you donate via a QCD is not included in your AGI. Furthermore, a QCD can satisfy all or part of your Required Minimum Distribution (RMD), which you are mandated to take starting at age 73. Normally, an RMD withdrawal would increase your AGI, but by using a QCD, you fulfill your obligation and support a cause you care about without adding a single dollar to your combined income.
Example: You are 75 and your RMD for the year is $8,000. You want to donate $5,000 to your local food bank. If you withdraw the $8,000 and then write a check, your AGI increases by $8,000. But if you instruct your IRA custodian to send a $5,000 QCD directly to the charity and you withdraw the remaining $3,000 for yourself, only that $3,000 is added to your AGI. This simple move can make a significant difference in your senior finances.
Strategy 3: Time Your Capital Gains
Selling assets like stocks, bonds, or real estate can generate capital gains, which are included in your AGI. If you know you need to sell an appreciated asset, timing is everything. Try to sell in a year when your other income is lower. For instance, if you plan to retire mid-year, it might be better to wait until the following calendar year to sell, when your only income might be from Social Security and smaller withdrawals.
Another related strategy is tax-loss harvesting. If you have investments that have lost value, you can sell them to realize a capital loss. This loss can be used to offset capital gains from your winning investments. If your losses exceed your gains, you can deduct up to $3,000 of the excess loss against your other income, further reducing your AGI.
Strategy 4: Consider Tax-Exempt Investments
As mentioned earlier, interest from municipal bonds is typically exempt from federal income tax. While this interest is included in the combined income formula, it doesn’t add to your AGI. If you have a significant amount of money in interest-bearing accounts like CDs or corporate bonds, the interest you earn is fully taxable. Shifting some of that money into tax-exempt municipal bonds could be a smart move, especially if you are in a higher tax bracket and are close to one of the Social Security tax thresholds. It’s a key part of long-term social security optimization.
Strategy 5: Plan Ahead with Roth Conversions
This is a more advanced strategy best done in the years *before* you start collecting Social Security, but it’s worth knowing about. A Roth conversion involves moving money from a traditional IRA to a Roth IRA. You have to pay income tax on the amount you convert in the year you do it. The goal is to do this in low-income years (for example, after you retire but before you claim Social Security). By paying the taxes now, you create a pool of tax-free money you can draw from later. Those future Roth withdrawals won’t raise your combined income, helping to keep your Social Security benefits from being taxed for the rest of your life.
