April 22

Creating a tax-efficient social security strategy

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As seen in the Bradenton Herald – April 27, 2021

According to the Social Security Administration, roughly 40% of people receiving benefits pay federal income tax on that income. By being strategic about withdrawing money from other accounts, there are ways to keep taxes down, and in doing so, you can further stretch your sustainable retirement income. 

The taxation of Social Security benefits depends on your total income and marital status. Ultimately it comes to your “provisional income,” a calculation you can find at ssa.gov. Income above certain thresholds can trigger taxation of social security at 50 to 85%.

In his book, Income Strategies: How to create a tax-efficient strategy to generate retirement income, Dr. William Reichenstein wrote about using an intelligent approach to social security with a combination of tax-efficient portfolio withdrawal techniques.  He believes that such a strategy may extend a retired household’s portfolio by up to seven years.  

The following are a couple of strategies to help reduce your taxable income.

Delay your Social Security 

Once you begin taking social security, you subject yourself to extra taxation as your benefits can cause a sharp spike in your marginal tax rate as income increases. See my previous article discussing the “Tax Torpedo,” “Medicare IRMAA,” and “Net Income Tax” for further clarification.

Being smart about how and when you claim Social Security is the low-hanging fruit of Reichenstein’s research. He estimates that it’s worth an additional $100,000 for a client who lives beyond the age of 85. The joint-life expectancy for a 65-year-old couple is age 89 based on the Social Security Administration’s 2007 Period Life Table.

Increase your Tax Diversification

While you are delaying Social Security, assess your opportunity to diversify tax-deferred assets like IRA’s and 401k’s into Tax-free assets through Roth conversions.  

Conventional wisdom says you should delay accessing Roth accounts until your alternatives are exhausted. But having access to tax-free dollars to use tactically to manage your marginal tax bracket can be a great tool to minimize lifetime taxation.

Manage Ordinary Income

Utilize tax-efficient investing and tax location strategies to minimize your exposure to unnecessary taxable income year over year. Beware of turning potential lower capital gains taxes into higher ordinary income taxes by using annuities and alternative products when held in non-qualified accounts. 

Review your tax returns and look for non-qualified dividends and discuss the need and location of underlying investment strategies. Look to offset gains with tax-loss harvesting at the end of each year.  

In years with a substantial distribution need – see first if it’s possible to defer into the following year. If not, consider pulling from a Roth or whether temporarily borrowing from an asset like a cash life policy makes sense.  

Look for Charity

Many times ordinary income needs are unavoidable, such as when you turn 72 and you need to pull money from your IRA’s due to Required Minimum distributions (RMDs). As appropriate to your situation, it might be in your interest to disclaim your RMD by electing a Qualified Charitable Distribution (QCD). By doing so, you will not get a deduction, but better yet, you will not include the income in your taxes for the year. The QCD election not only decreases your taxable income but could further reduce taxes on social security, medicare, and the net investment income tax.

For some, strategically using Social Security as one part of an overall retirement plan could help them achieve their desired standard of living while minimizing their tax bill now and throughout the years ahead.

Each person’s situation is different, and therefore you should customize a tax strategy to address your particular needs. For more information on calculating your taxable Social Security benefits – go to IRS.gov and look for Publication 915. Speak with a tax or financial advisor to learn more and put together a personalized plan.

Gardner Sherrill, CFP, MBA, is a CERTIFIED FINANCIAL PLANNERTM with Sherrill Wealth Management. To learn more, visit sherrillwealth.com, a Bradenton wealth management firm specialized on living in retirement.

This information is not intended to be a substitute for specific individualized tax or legal advice. Individual circumstances will vary. Please see your tax professional regarding your specific situation.

The opinions expressed in this material are not intended to provide specific advice or recommendations for any individual.

Securities and advisory services offered through LPL Financial, a registered investment advisor. Member FINRA/SIPC.


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About the author

Gardner is a CERTIFIED FINANCIAL PLANNER and principal of Sherrill Wealth Management in Bradenton, Florida. He has spent 20+ years in the wealth management field helping families negotiate the various obstacles and opportunities that retirement provides them. Read More

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