Don’t skip these 3 steps before applying for Social Security | Personal finance

(Adam Levy)

If you want to make the most of your Social Security benefits, you will need to make some important moves in your investment portfolio. Proper planning can help you keep most or all of your Social Security benefits instead of paying back a large portion of your taxes and will help you maximize the returns on the rest of your retirement portfolio.

Here are three steps to take before applying for Social Security to make the most of it.

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A brief guide to social security taxation

In order to reduce the taxes paid on Social Security, it helps to understand how the tax is calculated. The IRS uses a metric called “combined income” to determine which portion of your benefits, if any, are taxable. The combined income equals your adjusted gross income plus half of your Social Security income plus any non-taxable interest.

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Below are the thresholds that show how much of your Social Security benefits are considered taxable at various levels of combined income.

Taxable amount To separate Married
0% Under $ 25,000 Under $ 32,000
Up to 50% From $ 25,000 to $ 34,000 From $ 32,000 to $ 44,000
Up to 85% Over $ 34,000 Over $ 44,000

Table by author. Data source: Social Security Administration.

The reason it is “up to 50%” or “up to 85%” in the table above is that there is also a tax cap based on how much your income exceeds the threshold amounts. For example, if you are single with a combined income of $ 30,000 and social security benefits of $ 10,000, you would end up paying taxes not on half of the $ 10,000 in benefits, but rather on half the amount of $ 30,000 your combined income. exceeds the $ 25,000 mark. Half of $ 5,000 translates to $ 2,500. Similarly, if you are filing a joint declaration with a combined income of $ 40,000 and benefits of $ 15,000, you will pay tax on $ 4,000, half of the $ 8,000 amount of which the combined income exceeds the $ 32,000 threshold.

To minimize your taxes when you start receiving Social Security, here are three things to consider in the years leading up to retirement before claiming your benefits.

1. Roth conversions

The more money you can get into a Roth IRA before applying for Social Security benefits, the better your position will be to avoid taxes. This is because withdrawals from a Roth IRA do not count towards your adjusted gross income as you have already paid taxes on those funds in the year you contributed or converted to the Roth IRA.

Converting funds from a traditional or 401 (k) IRA to a Roth account requires payment of income tax on the converted amount. This is on top of any other income. So it’s best to do a Roth conversion in a year where the rest of your income is extremely low. It could be during a break in your career or early retirement before applying for Social Security.

Ideally, you will be able to keep your tax bill extremely low on these Roth conversions. Paying some tax now can save you a lot of tax following retirement, when your pre-tax retirement accounts start taking the required minimum distributions and you’re also taking income from Social Security.

2. Collection of capital gains

Another step to take in years when your income is low is called a tax gains levy. This is a process whereby you purposely book a capital gain on an investment to pay the capital gains tax. The trick is that you can pay 0% tax if you keep your taxable income below a certain threshold. In 2022, that threshold is $ 41,675 for individuals and $ 83,350 for those who submit jointly.

You can also keep those funds invested. In fact, unlike collecting tax losses, you can buy back your shares immediately without worrying.

The goal of collecting capital gains before retirement or during low-income years is to set yourself up to pay less in capital gains later on when you actually need the money for living expenses. That way, when you sell to raise money, you won’t increase your combined income that much. And if you have investments that decline in the intervening years, you may be able to take a loss and offset gains or income elsewhere to keep taxes low.

3. Change your asset allocation

While you are taking the steps above, it may be an opportunity to adjust your asset allocation in order to maximize your retirement portfolio. Instead of thinking of your Social Security benefits as something outside of your investments and savings, you should think of them more as a fixed income retirement asset.

Every year, Social Security retirement benefits are delayed from 62 to 70, their value increases. If you wait longer to apply for Social Security, it can cover more of your fixed income needs when you start getting benefits. Therefore, it makes sense to try to take into account the value of social security in your portfolio relative to other assets and make sure that the asset allocation is in line with the overall plan and risk profile.

In particular, while you wait to claim, it might make sense to have a higher percentage of your retirement stock investment portfolio than if you had previously stated. This can help you maximize your portfolio’s returns over the long term and also potentially avoid income taxes from bonds and other fixed income investments.

To be safe, you should rebalance your portfolio during retirement to maintain proper asset allocation. But if you are delaying Social Security, you should take into account its increasing value in your portfolio when deciding how to rebalance.

A few maneuvers in your retirement portfolio can make a difference in how much you have to spend when you need the money. Take these steps early in retirement and you will be able to enjoy a lower tax bill and larger portfolio later on.

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