After working long and hard for multiple decades, you can finally cash in on Social Security. Of course, you can get the highest possible payout if you wait to take out Social Security until you turn 70, but if you aren’t careful, you can end up paying a lot of taxes on that income.
Where you live and what strategies you use will influence how much you save in Social Security taxes. These strategies can give you a good financial foundation and preserve more of the income you will receive from the government.
If you have the flexibility to move to another state, you may want to consider a location that does not have any income taxes. Florida, Texas and Tennessee are some of the states that will not tax your Social Security benefits or any other income source.
Chad Gammon, certified financial planner (CFP) and founder of Custom Fit Financial, suggested moving to a tax-friendly state if you can, but emphasized that there’s more to cutting taxes than honing your focus on states without any income taxes.
“Selecting a state that doesn’t tax Social Security can help save quite a bit of money over your retirement. As you are researching states, however, you will want to look at the overall tax picture as taxes on IRA withdrawals, pension and property taxes may negate the savings for saving on Social Security taxes alone,” Gammon said.
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Although Social Security is a good income source, you can’t rely on it for retirement. Living costs can exceed your Social Security paycheck, and most people know this risk. That’s why it is common for people to invest in 401(k) plans, IRAs and other investment accounts.
However, there is a catch with traditional retirement plans. The withdrawals count as ordinary income and will push you into a higher tax bracket when combined with Social Security. That’s why it is good to withdraw from these accounts before taking out Social Security or converting them to Roth accounts. If you do not need the money right away, you should definitely do partial Roth conversions each year instead of withdrawing from your account.
“Another way to save might be Roth conversions before you claim Social Security. This may help lower your overall income before that time. And also help reduce income from future required minimum distributions. You should look at how this impacts your federal taxes as well,” Gammon suggested.
Waiting until you are 70 to take out Social Security gives you the maximum payout, but it also provides another benefit. It gives you time to move more of your funds into a Roth account. It’s better to get this out of the way before receiving Social Security to minimize the tax impact.
You will eventually have to make required minimum distributions, and by the time you reach that point, you may have to withdraw far more than you anticipated. This required minimum distribution is a percentage, so people with large portfolios may be forced to withdraw more than $100,000 per year at that point. Combine that with Social Security, and you can end up with exceptionally high tax rates.
“It might make sense to delay claiming Social Security until you are 70 to provide some additional years for Roth conversions. Then, once you claim Social Security, strategically using Roth accounts could help save on state taxes,” Gammon said.
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This article originally appeared on GOBankingRates.com: 3 State Tax Strategies To Keep More of Your Social Security in Retirement
