The age that Americans can begin collecting Social Security benefits varies based on year of birth. Because Social Security typically replaces only 40 percent of your preretirement income, you will need to supplement your retirement income with other sources in order to live comfortably. As you supplement your income, avoid Social Security tax traps with information about tax laws and penalties.
1. Learn the income thresholds. As of 2012, single taxpayers and taxpayers who are married but filing separately with an income below $25,000 annually should avoid income tax on all Social Security income. Income falling between $25,000 and $34,000 will place you in a position of paying income tax for up to 50 percent of Social Security income. Income above $34,000 results in as much as 85 percent of Social Security income being taxable. Married taxpayers filing jointly with an income below $32,000 should avoid income tax on all Social Security income. Income between $32,000 and $44,000 falls in the 50 percent tax bracket and income above $44,000 falls in the 85 percent tax bracket.
2. Determine your provisional income level. Add incomes together to find your modified adjusted gross income. Include wages, tax-exempt income, tax-free fringe benefits and 50 percent of your Social Security income. Subtract any necessary adjustments to your income to arrive at your adjusted gross income.
3. Sell off municipal bonds before you begin collecting Social Security benefits if your income level will threaten your Social Security benefits. Because municipal bond income is tax-free, it contributes to your provisional income level and may push your income over a taxable threshold.
4. Purchase taxable U.S. bonds instead. You should see a higher interest rate and the net return should be higher than municipal bonds as well, after factoring in the Social Security tax hit connected to the municipal bonds.
5. Plan withdrawals from regular IRAs carefully when figuring your provisional income level. You may be able to time your withdrawals so that you fall into the Social Security tax trap every other year instead of every year. Consider a Roth IRA conversion to avoid taxes on qualified withdrawals.
6. Consider the timing of stock sales and other assets carefully. Because this provisional income will contribute to your adjusted gross income, you may wish to unload these assets during years when your adjusted gross income is already above a taxable threshold.
7. Manage lump sum Social Security payments and Social Security disability benefits carefully. This income becomes a part of your provisional income, possibly pushing you over an income threshold. However, the IRS allows taxpayers to spread the taxes from this income out over a longer period. Use IRS Publication 915 to calculate your tax liability or hire a tax professional to assist you.
- Comstock Images/Comstock/Getty Images