The Retirement Account That Can Keep Your Social Security Benefits 100% Tax-Free
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Many retirees depend heavily on Social Security to make ends meet. If Social Security is your only income source in retirement, you’ll probably get to keep your monthly checks in full without having to worry about paying taxes on your benefits.
But if you have retirement income outside of Social Security, your benefits could be at risk of taxes — that is, unless you house your nest egg in the right account.
How taxes on Social Security benefits work
Social Security taxes on benefits hinge on provisional income. Provisional income is calculated as the total of your adjusted gross income (AGI), tax-exempt interest income (such as municipal bond interest), and 50% of your annual Social Security benefits.
If your provisional income falls between $25,000 and $34,000 and your tax-filing status is single, up to 50% of your Social Security benefits could be subject to taxes. Once your provisional income exceeds $34,000, up to 85% of your benefits could be taxed.
If your tax-filing status is married filing jointly and your provisional income is between $32,000 and $44,000, you could be hit with taxes on up to 50% of your Social Security benefits. Once your provisional income goes above $44,000, up to 85% of your benefits could be taxed.
You might think this system is unfair given that Social Security benefits are earned by paying taxes on wages. Having benefits taxed might seem like double taxation.
Unfortunately, Social Security relies on taxes from benefits to cover its expenses. So when you pay those taxes, you’re helping to keep benefits going. That may not seem like the best consolation prize, but it’s just how the system works.
How to avoid paying taxes on Social Security benefits
If you don’t like the idea of having to pay taxes on your Social Security checks, one of the most strategic moves you can make is keeping as much of your income as possible outside of the provisional income formula. And the best way to do that may be to keep your AGI low.
You can achieve that goal by housing your retirement nest egg in a Roth account, whether it’s a Roth 401(k) through your job or a Roth IRA. If you have your money in a traditional retirement account, a Roth conversion allows you to move it into a Roth IRA by paying taxes on the sum you transfer.
Roth account withdrawals are yours to enjoy tax-free. As such, they aren’t counted in AGI and don’t get added to provisional income.
Let’s say you’re single and collect $2,500 a month in Social Security, or $30,000 a year. If your only other retirement income is a $100,000 annual Roth IRA withdrawal, guess what? Your provisional income is only 50% of your annual Social Security benefit, or $15,000. You shouldn’t, in this situation, have to worry about your benefits being taxed.
Of course, it’s common for retirees to have multiple sources of income. And limiting yourself to Roth account withdrawals outside of Social Security may not be possible. But if you keep the bulk of your savings in a Roth account, you may find that you’re able to avoid paying taxes on Social Security, or at least only owe a minimal amount.
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Maurie Backman has more than a decade of experience writing about financial topics, including retirement, investing, Social Security, and real estate. Her work has appeared on sites that include The Motley Fool, USA Today, U.S. News & World Report, The Washington Post, and Kiplinger.
Prior to becoming a full-time financial writer, Maurie worked in the financial industry trading distressed debt. She then changed course and spent a few years designing electronic toys. After a stint in content marketing and UX, she shifted back into writing and has since covered everything from the housing market to estate planning to Medicare.
When she's not busy writing, Maurie can be found hiking, walking her dogs, driving her kids to their various sports practices and games, and curling up with a good book. She cooks on occasion and bakes way too often.
