The Sneaky Reason You Could Lose Some of Your Social Security Income

SSocial security is an important source of income for many older people, including those who have additional sources of income in retirement. Suppose you manage to amass a decent sized nest egg. Your savings could earn you, say, $20,000 in income per year. If you’re used to living on a lot more, Social Security can help fill the void.

But many seniors are shocked to learn that they are not entitled to their full Social Security income. Indeed, even people with low to moderate incomes are subject to taxation of their benefits at the federal level. And if this happens to you, it will result in a decrease in your Social Security pay.

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Will you lose some of your benefits?

Whether your Social Security earnings will be taxed will depend on your provisional earnings. This amount is calculated by taking half of your annual benefit amount and adding it to your non-Social Security income.

If your provisional income is $25,000 or more and you are single, you will have to pay taxes on your Social Security benefits. The same is true if you are married with a provisional income of $32,000 or more.

Obviously, these are not great thresholds. Let’s say you’re single and qualify for $1,500 a month, or $18,000 a year, from Social Security. If you also withdraw $20,000 a year from your nest egg and that is your only other source of income, you will have a total annual income of $38,000 and a temporary income of $29,000. This already puts you in a place where your benefits are taxed – although an annual income of $38,000 in no way makes you a wealthy retiree.

How to Avoid Social Security Taxes

The fact that there are such low thresholds at which taxes apply to social security puts many seniors at a disadvantage. But there’s one thing you can do to reduce your chances of having these benefits ultimately taxed: save in the right retirement plan.

If you house your retirement savings in a Roth IRA, your withdrawals from that plan won’t count toward interim income calculations. So, to use our example again, if you withdraw $20,000 per year from a Roth IRA and have no other income, and you collect $18,000 per year from Social Security, you will keep your annual income of $38,000. However, you reduce your provisional income to $9,000, thereby avoiding paying taxes on the money Social Security pays you.

Although Roth IRAs don’t offer the same immediate tax relief you’ll get from funding a traditional IRA, retirement withdrawals are tax-free. And Roth IRAs also have the advantage of letting you keep your money in your account indefinitely, whereas all other tax-advantaged retirement plans have minimum required distributions.

Keep more of your money

Social Security can end up being a major source of income for you down the line, so it pays to take steps to keep as much of your benefits as possible. By saving strategically, you may be able to avoid taxes on your benefits, at least at the federal level. Some states tax Social Security, but many of them at least offer exemptions so that low and moderate incomes are not affected by this burden.

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