A portion of your social security benefits may be subject to income tax if your modified adjusted gross income (MAGI), plus one-half your Social Security benefits, exceeds specific limits. Your MAGI equals adjusted gross income (or the adjusted gross income of you and your spouse if married and filing jointly), including wages, interest, dividends, taxable pensions, and other sources, tax-exempt interest income (e.g., interest from municipal bonds and qualified U.S. savings bonds), and amounts earned in a foreign country, U.S. possession, or Puerto Rico that are exempt from tax.
Up to 50 percent of your Social Security benefits may be subject to income tax if your combined income (MAGI plus one-half your Social Security benefits) exceeds $25,000 for an individual filing single, unmarried head of household, or qualified widow(er) with dependent ($32,000 if married and filing jointly).
If your combined income exceeds $34,000 ($44,000 if married and filing jointly), up to 85 percent of your benefits is taxable. If you are married and filing separately, up to 85 percent of your benefits will be taxed unless you and your spouse live apart for the entire year.
The good news is you won’t ever have to pay income tax on the whole of your Social Security income. But there are still steps you can take to reduce taxes on your Social Security income.
If you want to minimize tax, then you should try to keep your combined income at around $25,000. For example, let’s assume you received the average Social Security benefit of $15,000 in 2013. If you withdraw $17,500 from your IRA, your combined income will be right at $25,000. Your real income would be $32,500. That’s $17,500 from the IRA and $15,000 from Social Security. (In this example your combined income is $17,500 plus half of $15,000 which equals $25,000.)
If you take the standard deduction ($5,950) and standard exemption ($3,800), then you’ll only have to pay $778 in tax on an income of $32,000. That’s a 2 percent effective tax rate.
Diversify your retirement income. You are paying a 2% tax, but if $32,500 is not sufficient to support you, your retirement income needs diversification. For example, you can withdraw $5,000 from a Roth IRA, withdraw from your savings account or CDs, and tax does not apply on this income either.
Minimize expenses. The easiest way to minimize combined income is to keep your expenses low after retirement. A mortgage payment is the biggest monthly expense for many households. If you can eliminate that bill, then it will be much easier to live on $32,500 per year.
Around this time of the year, no one likes the word “tax”. The tax code is incredibly complicated, and it’s a huge headache to deal with. However, if you plan it right, you won’t have to pay much tax at all in retirement.
Get in touch with our tax professionals at GKM (info@gkmtax.com) for more information.
