Protect your retirement savings from these Social Security tax pitfalls

The Social Security system is an essential component of retirement planning for most Americans. A recent Gallup poll found that nearly 90% of retirees rely heavily or partly on Social Security during retirement. However, navigating the complex world of Social Security taxes can be challenging, and there are potential pitfalls that could deplete your monthly checks. Understanding the basics of how these taxes work is essential to avoid any surprises come tax time.

The amount of Social Security benefits you need to pay taxes on is based on your combined income, which includes your adjusted gross income, non-taxable interest income, and 50% of your Social Security income. If your combined income surpasses certain thresholds, a portion of your benefits will become taxable.

Unfortunately, these thresholds have not been adjusted for inflation in over 30 years, making it crucial to keep your combined income as low as possible to avoid taxes on Social Security. While you may not have control over your Social Security income, you can manage your overall adjusted gross income, which typically consists of retirement account withdrawals and capital gains from investments.

One major pitfall to be aware of is capital gains. The U.S. tax code offers preferential treatment to long-term investors, allowing many retirees to sell stock and bond holdings without incurring any taxes, thanks to the 0% tax bracket for capital gains. If you keep your taxable income below $47,025 for single filers or $94,050 for joint filers, you will not be subject to long-term capital gains taxes in 2024.

However, while these gains may not be directly taxed, they contribute to your adjusted gross income, thereby increasing your combined income and potentially making more of your Social Security income taxable.

Another pitfall lies in 401(k) and IRA withdrawals. You are taxed on these withdrawals as regular income and factor into your adjusted gross income. To avoid paying taxes on these withdrawals, restricting them to the standard deduction amount is advisable. However, even if you stay within the standard deduction, a significant portion of your Social Security income may still become taxable once your combined income exceeds $32,000.

It’s worth noting that certain states also tax Social Security benefits. In 2024, states like Colorado, Connecticut, and West Virginia, among others, have laws in place that impose taxes on these benefits. Understanding the tax laws specific to your state can help you anticipate any additional tax burdens during retirement.

In conclusion, carefully managing your retirement finances and avoiding common tax pitfalls can help maximize your Social Security benefits. By keeping your combined income low, being strategic with capital gains, and staying mindful of state taxes, you can protect your retirement savings and enjoy the benefits of Social Security.