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Welcome to the Limitless Retirement Podcast. My name is Danny Goodorf, the owner of Goodorf Financial Group. Whether retirement is on your horizon or you've already made the leap, this podcast tackles your most important questions in retirement. Every episode, I'm here to share valuable tips and strategies to help you succeed in retirement. So let's go ahead and get started with today's show.
The number of people paying taxes on their Social Security benefits is reaching an all -time high, and the situation is only getting worse. In this video, we'll look at the formula for taxing Social Security benefits. We'll also explore why the taxes are increasing, and we'll discuss ways to reduce or eliminate these taxes. For nearly five decades,
following the inception of Social Security, Social Security benefits were exempt from taxation. However, in 1984, during the Reagan administration, the first tax on Social Security benefits was implemented. It was estimated that approximately 10 % of Social Security recipients would be subject to this tax. Now, if we fast forward to 2022,
The landscape has changed and it has changed dramatically. A staggering 48 % of recipients pay taxes on a portion of their Social Security benefits. This amounted to nearly $50 billion of taxes paid on Social Security. This year, that percentage is expected to surpass the 50 % mark. Over the past 40 years, Social Security payments
and federal income tax brackets have both adjusted upwards. This was to account for the raising inflation. However, the income thresholds that determine whether Social Security benefits are subject to taxation have remained unchanged for four decades. This lack of adjustment has led to an ever -increasing number of retirees
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falling in to the tax bracket where their Social Security becomes taxable. Avoiding taxes on your Social Security benefits is possible, but it becomes increasingly challenging once you reach the age of 73. At that point, you must begin taking your required minimum distributions, otherwise known as RMDs. These distributions come from your 401ks,
your IRAs and your other tax deferred accounts. These mandatory withdrawals can push your income into a higher tax bracket, potentially subjecting a larger portion of your Social Security benefits to taxation. One small positive thing to note is that most states do not tax Social Security benefits. In fact, 37 states
have chosen not to tax these benefits. However, there are a few states that do impose taxes on your Social Security income. If you're able to navigate the federal tax on your Social Security, then you can be successful and it should also take care of any state tax obligations. So,
Let's explore how your Social Security benefits are taxed in more detail. The IRS uses a formula called provisional income, or otherwise known as combined income, to decide if your benefits will be taxed. Here's how it works. What you do is you take your taxable income, which includes things like W -2, investment income, dividend income,
could be rental income and any pension income that you have along with any other taxable income sources. Then you add in your tax -exempt interest, such as interest from municipal bonds, which is popular among high -income retirees. Then you include any excluded foreign income. In some cases, if you have earned income
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in a foreign country, you might be able to exclude it from your taxes. However, for the purpose of the provisional income formula, it needs to be added back in. Then what we do is we take 50 % of your Social Security benefit and we add it to the sum of the above items. This resulting figure is your provisional income or combined income. This number
is then compared against certain thresholds to determine what percentage of your Social Security benefits will be subject to taxation. It's important to note that this is not the actual tax amount, but rather the portion of your benefits that will be included in your taxable income. Let's go through a breakdown of these different thresholds. First,
we'll start with single filers. If your provisional income is less than 25 ,000, none of your benefits are taxed. The next threshold is if your provisional income is between 25 ,000 and 34 ,000, up to 50 % of your benefit is subject to taxation. If your provisional income exceeds
34 ,000, up to 85 % of your benefits is subject to tax. Now, let's jump into what that looks like for married couples who are filing jointly. The brackets will shift up a little bit when it comes to married couples. If your provisional income is less than 32 ,000, none of your benefits are subject to tax. If your provisional income is 32 ,000 to 34 ,000,
then up to 50 % of those benefits can be subject to tax. And if your provisional income exceeds $44 ,000 per year as a married couple filing jointly, then up to 85 % of your benefit is subject to tax. And I always like to remind clients that that's just the amount that's subject to some taxation. That doesn't mean
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you're gonna be taxed 50 % or 85 % on your social security benefits. So to help clarify that a little bit, let's consider a real life example to illustrate how this works. So suppose in our example couple, Bill and Mary, they have a combined social security benefit of 60 ,000 per year with no other income sources. To calculate their provisional income,
they would take 50 % of their $60 ,000 benefit, which equals $30 ,000. Since their provisional income is below the $32 ,000 threshold for married couples filing jointly, none of their Social Security benefits would be subject to taxation. Pretty straightforward, right? Now, let's introduce a twist.
Imagine that Bill and Mary are required to take $30 ,000 in required minimum distributions or RMDs from their tax deferred retirement accounts. This 30 ,000 would be considered ordinary income. However, instead of simply just paying the taxes on the 30 ,000 of RMDs, they would now owe taxes
on 50 ,000 because nearly 20 ,000 of their Social Security income now becomes subject to taxation due to this increased income from their RMDs. To illustrate this further, let's use a calculator. I'll link the calculator website in the show notes below for you to be able to experiment and test a couple different strategies on your own.
In this calculator, we'll input Bill and Mary's situation. Married status, filing jointly. Social Security benefits of 60 ,000. Other income, zero, initially. With just the 60 ,000 in Social Security benefits and no other income, their tax liability would be zero. However, when we add in the $30 ,000 from the RMDs to their income,
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the calculator shows that nearly $20 ,000 of their Social Security benefits would now become taxable. Now, let's consider a different scenario. Suppose a couple had 30 ,000 in Social Security benefits and 30 ,000 in other taxable income, such as pensions or RMDs. In this case, even though they had the same amount of total income as Bill and Mary,
which is 60 ,000, a higher proportion of their social security benefits would be subject to taxation. The calculator reveals that almost 7 ,000 of their social security benefits would be taxable. This discrepancy highlights what I believe is an archaic formula. Even though both couples have the same total income, the couple
with a higher percentage of their income coming from sources other than Social Security face a higher tax burden on their Social Security benefits. It's crucial to understand how different income sources can impact the taxation of your Social Security benefits. I encourage you to play around with the calculator using the link provided in the show notes. Experiment.
with different scenarios to gain a better understanding of how your benefits might be taxed and how various changes can affect the taxation of your Social Security income. So how can you avoid paying taxes on your Social Security benefits? The answer lies in careful planning. If you're younger and watching this video, the easiest way to plan ahead
is prioritizing contributions to Roth IRAs or Roth 401Ks. The rules surrounding Roth 401Ks continue to improve in the favor of taxpayers, making them a very attractive option for tax -free income in retirement. However, if you're watching this like most people watching this video,
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you're likely already have a significant amount of money in tax -deferred accounts like traditional 401ks and traditional IRAs. You'll eventually need to take distributions from these accounts either to cover your living expenses or to satisfy required minimum distributions. When you do, the additional ordinary income can trigger that higher tax
on your Social Security benefits. So I'm gonna walk you through a few strategies to help reduce the tax burden on your Social Security income and lower your overall tax liability. All right, strategy number one is delay claiming Social Security benefits. The longer you wait to start to receive benefits, the more time you have to draw down
your taxable and your tax deferred accounts before your social security income kicks in. For many people, it makes sense to delay claiming benefits until age 70, even if they retire as early as 62. This eight -year window allows for strategic withdrawals from other accounts. Strategy number two, withdraw money
from your traditional IRAs or your 401ks early. Do this if you don't need the money to live on. And even if you aren't planning a Roth conversion, consider moving the money from your tax -deferred account to your taxable account. While it might seem counterintuitive, a taxable account can often be more tax -advantaged
than your traditional IRA or 401k. Obviously, this depends on certain situations. All right, strategy number three, reduce dividend and interest payments in taxable accounts. Retirees often hold a significant portion of their portfolio in bonds and dividend paying stocks, which generate income. However, in a taxable account,
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and may be more beneficial to focus on higher growing assets with lower dividends and lower payouts. This approach will keep your taxable income lower. Strategy number four, taxable accounts often have too many foreign stocks. A diverse portfolio usually puts 20 to 30 % in them using ETFs or mutual funds.
Many people are unaware that there's often a tax rebate available on international funds because the companies have already paid tax from their country of origin. To avoid double taxation, you'll receive a rebate on the foreign taxes paid. If these holdings are in a taxable account, the rebate comes through as a tax deduction. However,
If they're in a qualified account, there's no benefit. To optimize this strategy, consider overweighting your international stock holdings in your taxable account while underweighting them in your qualified accounts. Next, you want to consider utilizing tax loss harvesting. In a taxable account, you can sell investments at a loss to offset any capital gains you might have.
Now, there are several rules surrounding tax loss harvesting that warrant a separate video. But here's a quick example. If you have a capital loss, it can offset ordinary income up to $3 ,000. If you have no capital gains to offset, a $30 ,000 capital loss can offset 3 ,000 of ordinary income.
potentially reducing your income for Social Security benefit taxation purposes. The remaining $27 ,000 in losses can now be carried forward to the next year. If you don't have any capital losses the following year, you can apply another $3 ,000 against your ordinary income and then roll the remaining $24 ,000 to the subsequent year.
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and you can do this year after year. Tax loss harvesting can be an effective way to reduce your taxable income in your portfolio. All right, the last strategy that we want to talk about is executing Roth conversions before claiming Social Security. This is by far one of the biggest tax strategies that we have available to us. We have another entire video dedicated to this topic.
which you can watch at another time. But leading into retirement between age 62, all the way up to when you have to start taking required minimum distributions at age 73, these give you a planning window. We call these your gap years. And you can do Roth conversions in your gap years, which means you're converting funds
from a traditional IRA or 401k to a Roth account before your Social Security benefit begins. This can help minimize the tax impact on your Social Security. By delaying Social Security, it provides a longer window for you to be able to perform these conversions in years when your income is lower. While Roth conversions
can still be done after you start receiving Social Security, the additional benefit or the additional ordinary income from the conversion may push more of your taxable Social Security benefits into that taxable range. So doing Roth conversions in those gap years can provide a lot of relief when it comes to your taxation of Social Security.
So that concludes today's videos. In the show notes, you'll find a link to the calculator. It lets you explore how much of your Social Security benefit will be taxed. It also shows how much other income affects that tax. I encourage you to play around with the calculator to gain a better understanding of how your specific Social Security benefit will be taxed.
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Thank you for watching. I hope you found this information useful. It can help you navigate the complexities of Social Security taxes. Remember, with careful planning and the right strategy, you can minimize or even eliminate taxes on your hard -earned Social Security income. Don't forget to like and share and subscribe. Stay tuned for updated future content.
that's designed to help you achieve a worry -free retirement. Have a great day. Thank you for listening to another episode of the Limitless Retirement Podcast. If you want to see how Goodorf Financial Group can help you get the most out of your money, go to goodorffinancial .com forward slash get started. This is where you can schedule a 20 minute call to see how our firm
can help prepare a free retirement assessment. Please remember, nothing we discuss on this podcast is intended to serve as advice. You should always consult a financial, legal, or tax professional that is familiar with your unique circumstances before making any financial decisions.