If you've recently reached the milestone age that will soon allow you to file for Social Security retirement benefits, you may be excited at the prospect of finally receiving these funds after paying Social Security and Medicare taxes for decades. However, for those who have other sources of income in retirement, these Social Security benefits can be taxed at your highest marginal tax rate -- often significantly reducing your take-home pay. What can you do to structure your assets to preserve more of your estate for your heirs? Read on to learn more about the taxation of Social Security payments and some ways to help you avoid taxes and keep your nest egg intact.
How are Social Security payments taxed?
While those whose Social Security payments are their sole source of income shouldn't be expected to pay income tax on this amount, those with alternative sources of income (like required minimum distributions from a retirement account or dividend payments) may be obligated to pay taxes on the majority of Social Security payments received.
If you're single or widowed and earn less than $25,000 per year in non-Social Security income, you won't be taxed on any of your Social Security income. However, if you make between $25,000 and $33,999 in other income, you'll need to pay federal income taxes (at your top marginal rate) on up to 50 percent of your Social Security earnings. If you earn more than $34,000 in non-Social Security income, you'll be taxed on up to 85 percent of your Social Security earnings.
For married couples, these income thresholds increase to between $32,000 and $43,999 for taxation of 50 percent of Social Security earnings, and those earning more than $44,000 will be taxed on up to 85 percent of these earnings.
What can you do to avoid taxation of your Social Security payments?
There are several ways to structure your taxable income so that you'll still be able to collect required minimum distributions from retirement accounts without subjecting your Social Security income to taxes.
You'll likely want to visit an estate planning attorney or certified financial planner (CFP) for advice specific to your income, assets, and expected lifestyle. In some cases, it may make sense to transfer your assets to an irrevocable trust, granting yourself a life estate in your primary residence and allowing the trustee to handle distributions and direct payments to ensure you remain below the taxability threshold without impacting your lifestyle.
You may also be able to reduce the amount of income subject to tax by converting traditional IRA holdings to a Roth IRA. Although you'll need to pay taxes on any converted amount during the year of conversion, all future withdrawals of contributions and gains will be tax-free.
For more information, contact Skeen Law Offices or a similar firm.