How to avoid paying taxes on Social Security income

Yes, it’s possible to avoid paying taxes on your Social Security, but it requires some careful maneuvering. While avoiding taxes on your monthly benefit check may sound like a good thing, retirees and other beneficiaries may want to think twice before trying to make it happen. Here’s how the experts say you can avoid taxes on Social Security, why you might not want to, and what taxes you may end up paying on your monthly benefit check.

Between 20% and 40% of property owners will challenge and win lower assessments and lower property tax bills.

If your property tax bill has increased significantly, you may have grounds for an appeal, particularly if the increase seems out of line with overall appreciation in your area.

Most jurisdictions give you 90 days after you receive a new assessment to appeal, although some close the appeals window after 30 days, says Pete Sepp, president of the National Taxpayers Union. Some lawyers handle property tax appeals on a contingency basis, but most homeowners can appeal on their own, Sepp says.

How much of your Social Security is taxable?

Some set the tax assessment at a percentage of market value—80%, for example—so don't be smug if you get a $90,000 assessment on a home you think is worth at least $100,000.

Some set the tax assessment at a percentage of market value—80%

How to minimize taxes on your Social Security

Even if a financial institution fails, money that’s insured by the federal government is protected. A press release from the FDIC says that since its founding, “no depositor has ever lost a penny of FDIC-insured funds.” The chance of your bank failing is also highly unlikely. FDIC data shows that so far, in 2020, only one bank has failed. In contrast, a decade ago in 2010, around 160 banks failed between the beginning and end of the year. “If we’re just talking about green money in your hands versus in the bank, there’s no reason for people to think that they need to hold onto physical dollars because there’s any sort of threat of a collapse to the banking system or the liquidity in the market,” McKenna says. “The government is making sure that the plumbing, the banking system, can continue to run smoothly.”

Some states allow anyone who owns and lives in a primary home to shield a portion of its value from taxation, or you may be eligible for credits based on your income or status as a senior citizen, veteran or disabled person.

Move income-generating assets into an IRA

Withdrawing too much cash is risky to an extent. Not only is the cash in your home not insured by the federal government, but when it’s in your apartment rather than in a high-yield savings account or CD, you’re not earning interest on those dollars. In the short-term, that doesn’t mean much. But in the long-term, you’re potentially missing out on a big chunk of change, depending on how much money you’ve taken out. Outside of a bank’s secure facilities, money at home is also at risk of being stolen. Similarly, you’ll probably be out of luck if something happens to your home. “If you have $100,000 hidden under your bed and your house burns down, there’s limits on what insurance will cover, ” McKenna adds. Of course, it never hurts to have some cash on hand, just in case you’re making an in-person payment and the retailer isn’t able to process cards temporarily or you’re dealing with someone in the service industry who only accepts cash. Otherwise, if you’re stuck at home, having a bunch of cash isn’t going to be of much benefit, McBride says. There’s nothing wrong with having access to some cash. But for any bills you choose to keep at home, just make sure it’s in a secure, fireproof safe, says Michael Foguth, president and founder of Foguth Financial Group.

How much cash you need depends

Pull up property cards of several homes of similar age and square footage and with the same number of bedrooms and bathrooms to see how their assessments line up with yours.

Step

It’s possible – and perfectly legal – to avoid paying taxes on your Social Security check. In fact, only about 40 percent of recipients pay any federal tax on their benefit. But here’s the caveat: To receive tax-free Social Security, your annual combined, or provisional, income must be under certain thresholds:

At the end of each year the Social Security Administration will send you a benefit statement that shows what you received during the year. You can use that to figure out how much of your benefit is taxable and what you might need to do to minimize your taxable income in the year ahead.

When it comes to deciding how much cash to withdraw, it varies based on your personal preference and what’s needed based on your individual circumstances. But taking out more money than usual may not be needed. “I don’t know that it’s any different from normal,” McBride says. “Maybe for peace of mind purposes you want to have an extra $100 or $200. A lot of that’s going to depend on what your expenses are and who you have to pay. But there’s more downside than upside to carrying excessive cash.” On the other hand, avoiding cash entirely could be extreme, despite fears that it could help spread the coronavirus. More than one in five respondents (22 percent) in a new J.D. Power survey say they’re planning to use less cash a result of that concern. Medical experts say it’s best to be cautious when handling cash and to wash your hands before touching your face. What’s more important is keeping a close eye on your finances and budget to determine whether you have enough money in your bank account to cover the basics and emergency savings. If you do need to venture out to an ATM, it’s best to choose one within your bank or credit union’s network, McBride says. That way, you’re not wasting money on unnecessary fees. And avoid making rash decisions or taking on additional debt, unless it’s absolutely necessary.

Coronavirus and handling cash

If you're worried about catching the coronavirus from handling paper money, the chances of that happening may be slim. You should still take precautions, though.

$25,000, if you’re filing as an individual $32,000, if you’re married filing jointly

For married filing separately, the Social Security Administration simply says that “you’ll probably pay taxes on your benefits.” Your combined income consists of three parts:

Your adjusted gross income, not including Social Security income

Add those amounts up and if you’re under the threshold for your filing status, you won’t be paying federal taxes on your benefit. Even if you’re above this threshold, however, you may not have to pay tax on your full benefit. You may pay taxes on only 50 percent of your benefit or on up to 85 percent of it, depending on your combined income.

For individual filers: Combined income between $25,000 and $34,000, up to 50 percent of your benefit is taxable Combined income above $34,000, up to 85 percent of your benefit is taxable For married filing jointly: Combined income between $32,000 and $44,000, up to 50 percent of your benefit is taxable Combined income above $44,000, up to 85 percent of your benefit is taxable

If your Social Security benefit is relatively fixed, albeit with small annual increases, you really have only two avenues left to get into that tax-free zone: reducing tax-exempt interest or adjusted gross income. And since most people don’t have tax-exempt interest, you’re left with one option. “Therefore, the secret is to reduce your adjusted gross income in order to prevent provisional income from triggering a tax on Social Security,” says Kelly Crane, president and chief investment officer at Napa Valley Wealth Management in St. Helena, California. Here are a few ways to reduce your adjusted gross income to get into the tax-free zone:

Most retirees are looking to pull money from their IRAs rather than put it in, but one way to reduce your income is to put income-generating assets into your IRA, where their interest or dividends won’t count immediately as income. This strategy doesn’t mean you necessarily put new money into an IRA – which might not be possible if you’re not working – but rather move income-producing assets in taxable accounts into the tax-advantaged sheltering of an IRA. At the same time you may be able to shift assets such as growth stocks into taxable accounts, where gains won’t be taxable until the asset is sold.

For example, if you have a bond in a taxable account and a growth stock in an IRA, you could sell those and buy the bond in the IRA and the stock in the taxable account. You’ll reduce your taxable income without reducing your total income. That said, if you make the switch, you’ll want to be sure you’re not incurring any unnecessary capital gains taxes in your taxable account, defeating the purpose of the switch.

Reduce business income

If you’re receiving partnership income or other business income, see if you can minimize it. “Reduce any K-1 or pass-through income from a business by increasing business deductions or expenses,” says Crane. This strategy might not be possible every year, but you could also consider bunching your deductions and expenses into alternating years, so that your Social Security income is taxable every other year.

Minimize withdrawals from your retirement plans

Money that you pull from your traditional IRA or traditional 401(k) will count as income in the year that you withdraw it. So if you can minimize those withdrawals or even not withdraw that money at all, it will help you get close to the tax-free threshold. Of course, this may not apply if you’re forced to take a required minimum distribution (RMD) that pushes you over the edge. But in 2020 you may be able to dodge the RMD requirement. “This year, a lot of folks won’t have to pay if they didn’t take their RMD or could return their RMD under the CARES Act,” says Paul Miller, CPA, of Miller & Company in the New York City area. The CARES Act allows you to avoid taking an RMD in 2020 or to replace it, if you’ve already withdrawn it. And new legislation allows anyone who took an RMD to replace the money. If you’re not forced to take an RMD in a given year, consider taking money from your Roth IRA or Roth 401(k) instead and avoid generating taxable income.

Donate your required minimum distribution

If you can’t wiggle out of taking your RMD from a traditional IRA, then donate it to charity to get into the tax-free zone. The donation could allow you to deduct the amount from your adjusted gross income. But you’ll have to be eligible for the qualified charitable distribution rule, including being over age 70½ and paying the distribution directly from the IRA to the charity. That’s a strategy that Crane suggests, though he acknowledges that some people will have too much income and simply won’t be able to lower their adjusted gross income.

Make sure you’re taking your maximum capital loss

If you’ve invested in stocks or bonds and have a loss on paper, you might want to sell and realize that loss so you can claim it as a tax deduction. The process is called tax-loss harvesting, and it can net you a sizable deduction from your income. The tax code allows you to write off up to a net $3,000 each year in investment losses. A write-off first reduces any other capital gains that you’ve incurred throughout the year. For example, if you have a $3,000 gain on one asset but a $6,000 loss on another, you can claim a deduction for the full $3,000 net loss. Any net loss beyond that $3,000 has to be carried forward to future years, at which point it can be used. And even if you can’t realize the full value of that net loss, it can still make sense to realize some loss, especially if it pushes your Social Security benefit into the tax-free area. Tax-loss harvesting works only in taxable accounts, not special tax-advantaged accounts such as an IRA.

Other things to watch out for

While everyone likes to minimize their taxes, especially ones that you can avoid without too much legwork, it’s important that you keep things in perspective. “Tax strategy should be part of your overall financial planning,” says Crane. “Don’t let tax strategy be the tail that wags the dog.” In other words, make the financial moves that maximize your after-tax income, but don’t make minimizing taxes your only goal. After all, those who earn no income also pay no taxes but earning no income is not a sensible financial path. For example, it can be better to find ways to maximize your Social Security benefits rather than minimizing your taxes. And it could be financially smart to first avoid some of the biggest Social Security blunders. Don’t forget that these rules apply to minimizing your tax at the federal level, but your state may tax your Social Security benefit. The laws differ by state, so it’s important to investigate how your state treats Social Security. “There really aren’t any tricks, you just have to be careful with your interest and dividends,” says Miller.

Bottom line

While the idea of tax-free Social Security is nice – and many people do avoid federal taxes on their benefit check – the cost of that is having an income that’s under a relatively low threshold. If you can make some sensible changes to how you realize income, then aiming for tax-free Social Security could make sense. But for many others, it would require a massive overhaul of their lifestyle or is otherwise simply impossible given their income and assets.

Tax-exempt interest 50 percent of your Social Security income