Three Ways to Beat Taxes on Social Security Income
As retirees well know, the federal government takes back part of your social security through taxes. Depending on your level of income the tax can be levied on up to 85% of your social security benefits. Can you beat the tax? Yes, many can and here’s how.
The general approach is to defer income. Deferred income does not appear on your tax return, it is not part of your taxable income. Therefore, deferred income can reduce the amount included for the social security benefit tax calculation. Tax-free income will not reduce the tax on your social security income, because tax-free income is included in the IRS social security tax calculation. Here are your sources of tax-deferred income:
Deferred Fixed Annuities. Some investors shy away from annuities, because they have the mistaken impression that all annuities tie up their money. In fact, annuities are issued in terms as short as one year. Reinvested interest is all deferred and such an investment can reduce or eliminate the tax on social security income.
Certain zero coupon bonds. There are a few issues of corporate zero coupon bonds that have tax deferred status. (Even though E-bonds are tax deferred, the IRS specifically includes them when calculating the taxes on your social security income.)
Below you will find an example of the effect on taxes for receiving interest from CDs versus tax-free bonds and annuities (note that CDs are FDIC insured and other investments are not).
Table 9.1
Effect on Taxes for Receiving Interest from CDs Versus
Annuities and Tax-Free Bonds
|
|
Scenario #1 Interest From CDs
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Scenario #2
Interest From Deferred Fixed Annuities
|
Scenario #3
Interest from Tax-Free Bonds
|
|
Interest
|
$10,000
|
$10,000
|
$10,000
|
|
Pensions
|
$25,000
|
$25,000
|
$25,000
|
|
Social Security Income
|
$20,000
|
$20,000
|
$20,000
|
|
Total Income
|
$55,000
|
$55,000
|
$55,000
|
|
Social Security Subject to Tax
|
$6,850
|
$1,500
|
$6,850
|
|
Adjusted Gross Income
|
$41,850
|
$26,500
|
$31,850
|
|
Total Fed. Tax
|
$4,084
|
$1,781
|
$2,584
|
The above figures are for a hypothetical married couple receiving social security income and how their tax liability changes under various investment scenarios, substituting a deferred annuity or municipal bond for a CD. Note that CDs are protected by FDIC insurance and other investments are not. Figures are calculated by TurboTax 1040 2000.
