Will your Social Security be taxed?

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You may be able to reduce the tax impact on your social security benefits
Especially if you work in retirement, your benefits could be affected. Take these steps now to help reduce your tax bill.

Key points

  • Lowering your "provisional income" may help reduce the amount of your Social Security benefit payment that is subject to tax
  • If you're working and start taking Social Security income before you reach "full retirement age," your benefits may be reduced
  • Investments that produce little or no taxable income, such as certain municipal bonds, may help reduce your overall tax burden
  • Use the Determine if you're on track to meet your retirement goals by using the Merrill Edge Retirement Evaluator™ to help determine if you're on track to meet your retirement goals
Many people are choosing to work well beyond traditional retirement age, allowing their Social Security benefits to supplement their salary from part-time or full-time employment. Yet, as financially advantageous as the combined income streams generally are, they can also increase the amount of federal income taxes you owe — and probably by more than you expect. As much as 85% of Social Security income may be taxable, and that can come as a real shock when you file your federal income tax return.Footnote 1 That's why it's important to Learn why it's important to develop a Social Security and retirement plan strategy.
How much of your Social Security income is taxable depends on a variety of factors, including your marital status and the additional income you might be earning. But with some preparation — which can include such steps as rebalancing your portfolio or structuring certain kinds of transactions — you can help minimize your tax liability.

Know how your Social Security benefits will be taxed

Taxes on Social Security retirement benefits are based on what is commonly referred to as your provisional income.
How provisional income is calculated
After you exceed the defined thresholds (see the chart below), a portion of your Social Security income will be included in your gross income and taxed at your marginal tax rate. So, for example, individuals in the 25% tax bracket could have up to 85% of their Social Security income taxed at 25%. In some cases, the additional gross income may also cause the taxpayer to move into a higher tax bracket.
Calculating your Social Security income tax
Source: Congressional Research Service, October 2016.

Be aware of your "full retirement age" — and why it matters

The Social Security Administration regards 66 as "Visit the Social Security Administration website for information on full retirement age" for those born in 1943 through 1954 — gradually transitioning up to age 67 for those born in the period between 1955 and 1960. Full retirement age is currently 67 for those born in 1960 or after. If you claim benefits before you reach that age and you're still working, your Social Security benefits will be reduced — and that reduction is in addition to any income taxes you may owe on the benefits you receive.
Examining your income sources well in advance of retirement gives you time to adjust your plans if necessary.
Beginning with the month you reach full retirement age, your earnings no longer reduce your benefits, no matter how much you earn. And, your Your benefit amount will be recalculated under certain earnings conditions. Learn more to leave out the months when they were reduced or withheld due to your excess earnings.
See the Social Security Administration's View the Social Security Administration's publication How Work Affects Your Benefits to learn about working while receiving Social Security payments.

Manage your income to limit taxes

As a way of minimizing tax liability, tax-planning professionals often advise clients to reduce their provisional income. "When you plan for retirement," says Vinay Navani, a CPA with accounting and consulting firm Wilkin & Guttenplan, P.C., "you need to think in terms of multiyear projections." For example, if you anticipate a big onetime event such as the sale of a business, you may be better off structuring the sale as an installment sale to be paid off over several years instead of receiving all of the cash in the year of the sale. For sales of large stock positions, consider selling gradually over several years to minimize the impact in any one year.
The simplest way to reduce your tax liability on Social Security income is to delay claiming Social Security benefits. After all, you generally only pay taxes on income you actually receive.

Choose investment options that reduce taxable income

Another option to help reduce taxes more generally may be to replace an investment that earns taxable income, such as a taxable bond portfolio, with one that produces little or no taxable income. For example, the income from most municipal bonds isn't subject to federal income tax and therefore reduces your taxable income overall.Footnote 2 But note that such income would increase the amount of your provisional income, which may affect the percentage of your Social Security income that is subject to federal income taxes. See View the article how Social Security fits into your retirement plan and work with a tax professional to find the best solution for your situation.

Know the regulations

If you plan to work past full retirement age, consult a tax advisor to examine the potential tax implications if you were also to receive Social Security income. You can use the worksheets in If you plan to work past full retirement age, calculate your tax liability by using the worksheets in Internal Revenue Service Publication 915 to help you calculate your tax liability. Also, check whether your state imposes taxes on Social Security benefits. The best chance to reduce taxes comes if you know what to expect and plan accordingly.

Delay collecting Social Security, if possible

Ultimately, the simplest way to reduce your tax liability on Social Security income is to delay claiming Social Security benefits. After all, you generally only pay taxes on income you actually receive. Plus, each month you wait to collect Social Security between the ages of 62 and 70 will boost your eventual monthly Social Security payment. Remember: Just because you can start receiving Social Security benefits doesn't mean it's the best option for you.
Next steps

Footnote 1 If you are married, filing separately and live with your spouse, up to 85% of your Social Security income is taxable.

Footnote 2 Certain investors' income may be subject to the federal Alternative Minimum Tax (AMT), and state and local taxes may also apply. This material should be regarded as general information on Social Security considerations and is not intended to provide specific Social Security advice. If you have questions regarding your particular situation, please contact your legal or tax advisor.

This material should be regarded as general information on Social Security considerations and is not intended to provide specific social security advice. If you have questions regarding your particular situation, please contact your legal or tax advisor.

Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

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