Most people who collect social security will pay taxes on that income.  In fact, up to 85% of your social security may be taxed.  As of 1983, social security payments have been subject to taxation, depending on your other income.  Seniors living only on social security will not be taxed.  But…you may be able to limit your taxes by taking certain steps.

With careful planning, you can limit this taxation.  There is a calculation used to determine how much of your social security will be taxed.  This calculation is generally referred to as Provisional Income.  Add up all your taxable income, whether it comes from a 401k, IRA, salary, capital gains, etc. even tax-free muni bonds and then add in 1/2 of your social security payment.  If you are single and your provisional income is over $34,000 then up to 85% of your social security will be taxed at your ordinary tax rate.  If you’re married, the threshold is $4,400 for that 85% taxation.  Rather than going through the entire exercise, here is a handy calculator to do the math for you.

What about state taxes? If you live in Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, or West Virginia you are subject to state taxes on your social security.  Check with your state to determine your tax.

One way of avoiding the tax is to move your income sources to tax-exempt vehicles.  For example, you can convert any money you have in an IRA into a Roth IRA. If you are over 59 1/2, there are no penalties, but you will have to pay the tax on the amount you transfer.  This is often called a “back door IRA.”  The trick is to move only the amount each year that won’t put you into the next higher tax bracket. Once the funds are in a Roth, they will no longer be included in the provisional income calculation, plus you have added benefit of tax-free growth and distributions and no RMD’s.  As a bonus, the Trump tax cuts are due to sunset in 2026.  Tax rates are sure to go up, especially considering all the money the government is spending on our Covid stimulus payments and raising the national debt.  If you convert your IRAs and 401k now, you get to pay the taxes now while they are still “on sale.”

It’s best to work these and other available strategies out with your financial advisor.