How to Avoid Paying Taxes on Your Social Security

Contributor

By Mark P Cussen, CFP, CMFC
eHow Contributing Writer

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(9 Ratings)

Keep your cash.

Paying taxes on your monthly Social Security income is no fun. Learn how you can reduce or avoid these taxes in many cases.

Difficulty: Moderate

Instructions

Things You'll Need:

Last year's 1040

Step 1

First, look at the front side of your tax return from last year. The first part of the form 1040 lists all of the different sources of income that you were taxed on. Look at the line that lists Social Security income. If there is a number (such as $11,491) that is listed on the right side of the form from that row, then you had taxable Social Security income.
Step 2

Social Security income is only taxable if your modified adjusted gross income is $25,000 or more if you are a single filer, or $32,000 or more if you file jointly. Unfortunately, even some forms of tax-free income, such as municipal bond interest, can be used to calculate this income threshold.
Step 3

If your tax return shows that you are paying taxes as a result of your Social Security income, there may be a remedy available. The formula that determines your Social Security taxability includes all forms of taxable investment income, such as interest, dividends and capital gains. Reallocating some or all of these income items into tax deferred or tax-free accounts or vehicles can reduce or eliminate the tax on your Social Security income.
Step 4

There are several ways to remove taxation on your taxable investment income. One is to move taxable interest-bearing instruments such as corporate bonds, CDs or preferred stocks into a tax-deferred vehicle such as a fixed or variable annuity. Another is to sell your taxable investments and buy them back inside a traditional or Roth IRA, although this method can generate current taxable capital gains. Remember that it may not be necessary to sell or reposition all of your taxable investments, just enough to lower your income to where your Social Security benefits will not be taxed. The real factor in this equation often comes from taxable interest that is simply reinvested and is not paid out as income. This "unused" interest will not be counted as income if it grows inside an annuity or IRA. For investors that have several hundred thousand dollars in bonds or CDs, a fixed annuity can offer higher rates, tax relief and other benefits.