5 Tips to Reduce Taxes on Social Security Income

By Jon Flynn

Had enough of paying taxes on your social security income?  There are some ways to reduce the taxability of your benefits, but first, it’s important to learn something about what the IRS calls the “Provisional Income Equation”.

Without boring you with complicated mathematics, it goes something like this: take your Adjusted Gross Income (AGI) and add to that any Tax-Exempt Interest you might have, and then add to that combined total one-half of your social security benefits. Then, depending on your filing status and how much your provisional income turns out to be, your benefits are either taxed to some degree or not.

Check out these “five tips” to potentially reduce or even eliminate the taxes that you send to Uncle Sam on your social security income benefits…..

1.      Reduce investment income.  Sources of income like interest on taxable bonds, CD’s,  etc.., all increase your provisional income.  If you aren’t using this income to meet expenses, and are reinvesting it instead, you may want to consider an investment vehicle that would provide a tax sheltering feature.  Investment vehicles, for example, like dividend paying stock and tax sheltered annuities can provide the ability to defer interest.

2.      Apply for social security benefits at age 62.  For those who haven’t reached 62 yet, it may make sense to start receiving your benefits early (at 62) as opposed to waiting until you’re 65.  Sure, your monthly benefit will be lower, but your total income will also be lower as a result.  Be careful here not to “let the tax tail wag the tax dog”.  Obviously, this decision would need to be weighed very carefully against everything else in your total financial picture.

3.      Roth IRA Conversion.  The distributions that you receive from qualified retirement plans are typically considered taxable income and thus included in the provisional income calculation.  Roth IRA distributions, however, are not considered taxable income.  One strategy is to convert some or even all of your 401(k) and traditional IRA’s to a Roth IRA.   This concept would involve paying taxes now on any converted amounts.  This approach would affect your SSI taxability this one time.  However, in future years, the distributions that you would receive from your Roth would not be considered taxable income.  Again, tread carefully here.

4.      Consider itemizing your deductions.  Things like charitable contributions, medical expenses, professional fees, etc.., can really add up.  Don’t just assume that it’s not worth it to itemize.

5.      Capital Losses.  Taking losses each year on underperforming investments can reduce AGI thus reducing your provisional income.  Many people are sitting on losses suffered during the recent economic crisis.  Why not try and make some lemonade out of your lemons?

Everybody’s situation is different and arriving at solutions can get complicated.  So always consult with financial, legal, and tax professionals before making any decisions. For the actual calculation worksheet, please see the instructions on page 28 of the IRS’s 1040 Instructional booklet for 2009. 

Jon Flynn is a Certified Financial Planner ^TM and owner of Flynn Financial in Eynon. He is a Representative of Securities America, Inc., Member FINRA/SIPC and of Securities America Advisors, Inc. Flynn Financial and Securities America are unaffiliated.   Mr. Flynn can be reached at 570-876-5000.