9 Ways to Help Clients Reduce Taxes on Social Security

There are a number of ways you and your clients can lower or eliminate taxes on these benefits.

Social Security is an important component of retirement income planning for most of your clients. When should they claim their benefits/? What is an optimal claiming strategy for a married couple?

Retirement income planning isn’t complete without also considering taxes. Strategic tax planning can help clients reduce or avoid taxes on their Social Security benefits.

How Are Social Security Benefits Taxed/?

Social security benefits can be subject to taxes as follows.

If your client files as single and their combined income (also known as provisional income) is:

If your client files as married and joint and their combined income is:

Clients who are married and file separately will likely pay taxes on their benefits as well.

Note that combined income is defined as:

Adjusted gross income + nontaxable interest + half of their Social Security benefits.

Planning Options to Reduce Taxes on Social Security

There are a number of planning steps you and your clients can take to try and reduce the taxes on their Social Security in retirement. By default, most of these steps fall into the category of retirement tax planning, which is important even outside the context of trying to reduce or eliminate taxes applicable to their Social Security benefits.

Here are some options to consider. The best options will vary based on your client’s individual situation.

1. Prioritize retirement income planning.

Retirement income planning is one of the most important things you do for your clients in retirement. Their withdrawal strategy should be evaluated regularly, in most cases every year, to be sure that they are withdrawing funds from their various accounts in the most tax-efficient fashion.

This is especially important once they claim their Social Security benefits. 

2. Reduce RMDs. 

With many of your retired clients, one of the larger generators of taxable income each year is their required minimum distributions from traditional IRAs, 401(k)s and other traditional retirement accounts.

For clients who have not yet reached the age when RMDs commence, the years leading up to their RMD age represent a good time to take planning steps that will reduce RMDs in the later years of retirement. Many of the additional strategies discussed will help your clients reduce RMDs. 

3. Push for Roth contributions.

Having your client make contributions to Roth accounts, including Roth IRAs and a Roth 401(k) or a Roth option in other workplace retirement plans such as a 403(b), can help them accumulate significant balances that can be tapped tax-free. Qualified Roth distributions are not counted as combined income and will not affect the taxation of a client’s Social Security benefits.

Roth accounts provide your clients with flexibility regarding which retirement accounts to tap in a given year. Tapping Roth accounts versus traditional retirement accounts to the extent possible can help lower their taxable income in a year where their income might otherwise be a bit higher.

It’s important to ensure that the five-year rule on these accounts is satisfied so that the withdrawal meets the criteria for a qualified distribution. 

Roth IRAs are not subject to RMDs, which are often one of the major sources of taxable income for retirees. This also applies to designated Roth accounts in 401(k)s and other qualified plans beginning in 2024. 

4. Consider Roth conversions. 

Another planning strategy to consider in the years prior to claiming Social Security is doing a Roth conversion. Ideally, you can work with your client to do the conversions in years when their income might be on the low side, either during their working years or in the first few years of retirement.

Money converted to a Roth IRA will no longer be subject to RMDs, reducing their future RMDs and the taxes associated with them. Additionally, money converted to a Roth IRA can be withdrawn tax-free once the five-year rule and other requirements have been satisfied. 

5. Review QLACs.

Qualified longevity annuity contracts are deferred annuities purchased inside of a retirement plan such as a IRA or a 401(k). Due to a change made in the Setting Every Community Up for Retirement Enhancement (Secure) 2.0 Act, clients can now use up to $200,000 of their retirement account balance to purchase a QLAC. 

From a tax planning perspective, the money used for the contract premium is excluded from their RMDs until they commence receiving the annuity payments. This can be stretched out as far as age 85. 

6. Don’t forget QCDs.

Qualified charitable distributions from a traditional IRA are available to those who are at least age 70 ½. Clients who are charitably inclined can transfer up to $100,000 from their traditional IRA to a qualified charity or nonprofit organization.

While there are no charitable deductions available with a QCD, the withdrawals are not taxed. 

Under Secure 2.0 the annual QCD limit will be indexed for inflation beginning in 2024. The age remains at 70 ½ even with the increases in the age to start RMDs. 

QCDs taken prior to commencing  RMDs will serve to reduce the amount of future RMDs and the taxes associated with them. Once your client starts their RMDs, QCDs can be used to satisfy some or all of their RMD requirements.

Also, QCDs can be taken over and above the amount of your client’s RMD amount. QCDs taken in excess of RMD amounts will also serve to reduce the amount of RMDs in subsequent years. 

7. Be sure to prioritize tax-loss harvesting.

For clients who will be realizing capital gains in their taxable portfolios, be sure to look for tax-loss harvesting opportunities to offset this income to the extent possible. This can help minimize the impact of these gains on their income.

Many advisors use tax-loss harvesting as an integral part of their rebalancing process with client portfolios. 

8. Make charitable contributions count.

Charitable contributions can provide a way to reduce taxable income to the extent that they can allow your client to itemize deductions. The deduction is limited to a percentage of their adjusted gross income (AGI).

This can be as high as 60% of AGI, but may be limited to 20%, 30% or 50% depending on the type of deduction and other factors. 

9. Combine several years’ worth of expenses.

It may not be possible to keep a client’s income low enough to avoid taxation of their Social Security benefits every year. It might make sense to bunch expenses and deductions into a single year to maximize deductions and minimize taxable income for the year. 

The expenses to bunch into a single year usually include multiple years’ worth of charitable donations and medical expenses in excess of 7.5% of income for procedures where there is flexibility in the timing.

If their state and local taxes are under the $10,000 SALT cap, they might consider making an extra property tax payment that year to maximize this deduction. 

They may only be able to do this every two or three years, but this can still be helpful in reducing their income tax bill.

Another Reason to Keep Income Low

Social Security is not the only federal program in which higher-income participants face additional costs. Medicare adds an income-related monthly adjustment amount, also known as an IRMAA surcharge, to Part B and Part D premiums for retirees above certain income thresholds.

These premium adjustments are based on income from two years prior, and the strategies to reduce your client’s taxes on their Social Security can also be effective in reducing their income for the purposes of their Medicare premiums.

It should be noted that the Medicare IRMAA income thresholds are considerably higher than the thresholds for the taxation of Social Security. 

Keep Things in Perspective

The income thresholds for the taxation of Social Security are quite low, and there have been calls for them to be raised.

Even if you cannot work out a plan with your client to keep their income below these thresholds every year, the type of planning strategies discussed above can help your clients manage their overall tax liability in retirement, saving them money and allowing them to stretch their nest egg. 

(Photo: Adobe Stock)

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