Since it’s Super Bowl Sunday as I write this post, let’s discuss strategy as it pertains to winning the Social Security benefit game. If you want to be successful at increasing your after-tax Social Security benefits, you need to have a winning strategy. Hopefully you read Part 1 of this post and if you’re not yet receiving benefits, you’ve begun to implement your pre-benefit receipt game plan.
Once you’ve begun receiving your retirement benefits, there are two halves to winning the game when it comes to increasing after-tax benefits: (1) reduce taxable benefits, and (2) reduce the tax attributable to your benefits. If you’ve read Parts 1 and 2 and/or the previous two-part Say Goodbye to Up to 30% of Your Social Security Benefits series, you know that reduction of taxable benefits is all about minimizing the three components of “combined income,” i.e., (1) 50% of Social Security benefits, (2) adjusted gross income, and (3) tax-exempt income. Components #1 and #3 were addressed in Part 2.
Let’s turn our attention to component #2 – adjusted gross income, or “AGI.” As defined in Retirement Income Visions‘ Glossary, “adjusted gross income” is equal to gross income from taxable sources less deductions from gross income that are allowable even if you don’t itemize deductions. To the extent that you’re able to (a) reduce your gross income from taxable sources and/or (b) increase your deductions from gross income, you will reduce the amount of your adjusted gross income and, in turn, reduce your “combined income.”
Reduce Gross Income From Taxable Sources
Even though you can reduce your taxable Social Security benefits by reducing your gross income, why would you want to do this? After all, don’t you want to maximize your salary, self-employment income, pension income, rental income, partnership income, interest and dividend income, capital gains, etc.? Absolutely — with a caveat. Your goal should always be to maximize cash flow while minimizing taxable income. For those of you who receive annual Schedule K-1’s from entities in which you are a partner, shareholder, or limited liability company member, you know that quite often there’s a difference between what shows up on your K-1 as taxable income vs. the cash distributions you receive.
How do you reduce your gross income when you’re receiving Social Security benefits without negatively impacting your cash flow? Here are six ways to do this:
- For taxable investments, i.e., nonretirement accounts, invest in immediate and/or deferred income annuities since a portion (sometimes substantial) of the distributions will be nontaxable.
- Sell assets with unrealized losses to offset capital gains recognized earlier in the year.
- Minimize distributions in excess of required minimum distributions (“RMD’s”) from self-managed non-Roth IRA retirement plans.
- Minimize taxable Roth IRA conversions.
- If you have net rental income from your rental property(ies), transfer mortgage balances from your home to one or more of your rental properties to increase your rental property interest deduction up to the amount of your net rental income. Even though your overall mortgage interest deduction may be unchanged, you may be able to reduce your taxable Social Security benefits.
- Look for opportunities to sell properties that have passive activity loss carry forwards in order to recognize the losses.
Increase Deductions From Gross Income
When we think of tax deductions, what comes to mind most often are “itemized deductions,” including mortgage interest, real estate taxes, charitable contributions, etc. While these types of deductions reduce taxable income, they don’t reduce adjusted gross income. Although the opportunities in this area are limited, and assuming you’re not paying alimony, here’s three possibilities:
- If you’re less than 70-1/2, maximize your IRA deduction.
- If you’re self-employed, maximize your self-employed pension plan, i.e., SEP-IRA deduction.
- If you’re not eligible for Medicare, establish and maximize contributions to a health savings account (“HSA”).
By the time you read this post, Super Bowl Sunday will be a memory. If you’re receiving Social Security benefits, your game and associated battle to reduce the taxation of your benefits is ongoing. Do you have a winning strategy in place to maximize your after-tax Social Security benefits?
Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.