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How is social security income taxed?

I've spent about 10 years working with people on retirement income planning.

For many people in America, Social Security income will make up a large percentage of their monthly retirement income.

I've also seen situations where social security checks account for 80% or more of a household monthly retirement income.

For this reason, it's important to understand how social security benefits are taxed and identify some strategies to potentially lower or eliminate social security income tax all together.

Start with combined income.

The most basic way I can star off this conversation is to tell you that either 0%, 50%, or 85% of your social security income benefit will be taxed. Yes you read that right, some people pay zero taxes at all on their social security while others will pay tax on up to 85% of their retirement check!

The amount of your benefit that will be taxed depends on a figure know as your household "combined income".

Combined Income = Adjusted Gross Income + 1/2 Social Security + non taxable interest

You won't find your combined income on any of your tax returns and the income thresholds are much different than what you'll see on a normal tax table. Here is the combined income table that will determine which percentage of your social security benefit will be taxed. These income limits are as of the tax year 2021.

It's a little bit more complicated than finding your combined income on the table and doing some quick math. Let's take a look at an example.

Mary McDonald has a pension paying her $24,000 annually, and a Social Security benefit paying her $12,000 every year. Her husband Ted takes withdrawals from his traditional IRA in the amount of $20,000 per year and also has Social Security benefit which pays out $12,000. The McDonald’s AGI is $44,000 and their combined income is $56,000.

AGI = $24,000 pension + $20,000 IRA withdrawal = $44,000

Combined Income = AGI + $6,000 (1/2 Mary SS benefit) + $6,000 (1/2 Ted SS benefit) = $56,000.

The McDonalds combined income is $12,000 over the upper threshold limit of $44,000, so $16,200 of their social security benefits will be included in their taxable income.

The first $6,000: The McDonalds combined income completely filled the middle 50% combined income range, so 50% of $12,000 (the difference between $44,000 and $32,000) is included.

The next $10,200: The McDonalds combined income also surpassed the upper threshold limit of $44,000 by $12,000 which falls in the 85% inclusion threshold (85% of $12,000 is $10,200).

As AGI increases, the process to determine your social security inclusion amount remains the same until you essentially max out and 85% of your benefits are included in taxable income.


As you may have noticed, the combined income thresholds may be considered relatively low. For some people, it may not be possible to avoid the highest tax rate on their social security benefit simply because they make too much money and there's no way to avoid it -- must be nice!

For the vast majority of Americans, however, there are several strategies that you can use to decrease taxes paid on your SS benefit. With the right amount of foresight and planning, deploying a combination of these strategies could save you thousands in taxes throughout your retirement.

Create a plan and strategize.

It's important to first have a general understanding of not only you combined income and social security benefit amounts, but also where your income is coming from. This will help you identify how your future social security might be taxed and identify solutions and strategies to potentially help lower the total tax burden on your SS benefit.

Here are a few strategies to consider when you're ready.

1. Delaying Social Security until fully retired.

Delaying your Social Security benefit is a good practice whenever possible. First of all the longer you wait to take your Social Security benefit, the greater your Social Security income will be. Your maximum Social Security benefit is achieved at age 70. If you wait until your full retirement age ("FRA" --full retirement age is different for everybody based on your year of birth) you will receive a 8% increase on your Social Security benefit each year up until you achieve age 70 at which point your benefit maxes out.

At age 70, everybody must turn on their Social Security benefits, although you may wait to file for Medicare until the day you retire if you’re still working.

It’s also important to hold off taking your Social Security if you're still employed and below your full retirement age. This is because of something know as the earnings test, which penalizes your social security benefit if you're under FRA and making too much earning income while drawing SS benefits. The income limitations are very low and as of the year 2021, and individual can only make $18,960 or less to avoid being penalized on drawing their Social Security income.

Your social security benefit will be reduced by $1 for every $2 you earn above the $18,960 limit.

Essentially, by waiting to take your social security you achieve a 3-pack of positive outcomes:

  1. Higher annual income.

  2. Avoidance of the earnings test penalty.

  3. Lower AGI, combined income, and potential avoidance of SS benefits subject to taxable income.


2. Do Roth conversions with your pretax retirement accounts.

As mentioned previously, withdrawals from pretax retirement accounts such as 401(k) plans, traditional IRAs and SEP IRA ‘s increase your combined income figure when determining the portion of your Social Security benefit that is included in your taxable income.

Surprisingly to some, withdrawals from after-tax accounts such as Roth IRA‘s do not count towards your combined income figure.

Pretax accounts such as traditional IRAs and 401(k) plans provide upfront tax deductions for the amount of money saved in a given tax year. When money is withdrawn from these accounts in the future they are 100% included in your taxable income.

On the other hand, Roth IRA’s do not provide a tax benefit for amounts saved in any given tax year. However when money is withdrawn from these accounts in the future, they are tax free distributions and are therefore not Included in taxable income.

Performing a Roth conversion involves transferring some amount of money held in a pretax retirement account into a Roth IRA.

The money that is transferred from a pretax account over to a Roth IRA will generate a tax bill in the year in which the transfer occurs. For example, a household with an effective tax rate of 20% would pay $2000 to do a Roth conversion on $10,000 from a traditional IRA to a Roth IRA.

You’re probably asking yourself why would you do this?

When money is converted to a Roth IRA it continues to grow tax-deferred. As mentioned before, down the road when money is withdrawn from a Roth IRA no taxes will be owed. Also, distributions from a Roth IRA don't count towards your taxable income and will therefore not push you into a higher combined income bracket.

This creates a tax arbitrage situation. Basically, move as much money from pretax to Roth accounts when income is relatively low or your current tax plan allows.

Roth conversions are extremely effective in years where your household income is down relative to other tax years. Since your total income is down you may be able to afford more Roth conversions without paying an extraordinary amount of extra tax, or any tax at all!

The standard deduction or itemized deductions along with credits like child tax credits and earned income credits could offset the current tax burden of doing Roth conversions.

Doing a cost/benefit analysis is important when considering Roth conversations but if done properly, could save you thousands.

The impact of Roth conversions in the scope of this discussion is twofold:

  1. You are not taxed on Roth IRA withdrawals in retirement.

  2. Roth distributions are excluded from combined income so they help lower the chances that social security will be taxed.


3. Properly time capital gains transactions.

Common capital gain transactions include the sale of real estate, the sale of stocks and bonds, and the sale or exchange of mutual funds.

When you hold a capital asset and sell it for a gain you will need to pay capital gains tax on the difference between the purchase price and the sale price. If you hold the capital asset for more than 365 calendar days, you will pay capital gains tax at a lower long-term rates. Alternatively if you hold capital assets for 265 days or less you will pay capital gains tax at the higher short term rates.

Either way it is important to properly time the sale of your capital assets based on your current household income situation. Generally if your household income is relatively low in a given tax year, it may make sense to sell some of your appreciated capital assets.

Since that goal is to keep your combined income as low as possible, properly time in your capital gains transactions will help Reduce the overall taxation of your Social Security benefit... not to mention keep you out of higher federal tax brackets altogether!


4. Consider gifting away income-producing property to your beneficiaries.

Included in the combined income figure are both taxable interest and dividends (included in AGI) as well as non-taxable interest and dividends generated by investments you may have in your portfolio.

If you hold investments that are generating either taxable or non-taxable income, you may consider gifting them to family members or other beneficiaries.

Doing so will remove this income from your tax return each year and ultimately lower you are combined income figure. This is especially effective if you plan on leaving these assets to your beneficiaries at your death. Getting them out of your estate now will potentially save you thousands in tax dollars while you’re still living.

Make sure you are familiar with gifting limitations and exclusions. There is an annual gift limit of $15,000 per individual and a lifetime gift amount of $11,580,000, which is tied directly to the estate tax system.

A post about gift and estate tax will be coming in the near future.

On a related but slightly unrelated note, do not gift highly appreciated capital assets or investments to beneficiaries while you’re living. Instead consider leaving these highly appreciated assets to your beneficiaries through a properly constructed estate plan at your death.

This is because your beneficiaries will receive a step up in cost basis and they will acquire your appreciated asset at the fair market value of the asset at your date of death. They will therefore not need to pay capital gains tax on the difference between your original purchase price and their acquisition price at your death.

Disclaimer: President Biden‘s tax bill involves getting rid of this step up in basis estate planning strategy. If this part of the bill is approved, beneficiaries will not receive a step up in cost basis at the time of your death and will rather acquire the asset at your purchase cost.


At the end of the day you may be able to avoid or reduce tax on your social security, or you may not.

Either way I would suggest that you know what combined income is and know the range of outcomes for taxation on your benefits. In most cases, some planning can be done to help save you some money.

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