Reduce the Risk of Social Security Taxation with Fixed Anuities

Social Security benefits play an important role in your overall retirement income strategy. But there's one potentially costly drawback to those benefits — you may have to pay income taxes on your Social Security payments.

A tax-deferred fixed annuity can play an important role to reduce the impact and possibly even eliminate taxes on your Social Security benefits.

The Problem — You May Owe Taxes on Social Security Income
Taxes on Social Security income begin to apply as certain income levels are reached. For instance, for a married couple where the combination of their Modified Adjusted Gross Income plus 50% of Social Security benefits exceeds $32,000 in a year, half of their Social Security taxes will be subject to income taxes at ordinary income tax rates. (For a single tax filer, taxes become an issue when that combination exceeds $25,000.)

For example, if your income level exceeds the threshold, and you receive $18,000 in Social Security benefits over a calendar year, taxes will apply to $9,000 of that annual benefit. For someone in the 28% tax bracket, that can mean a tax bill of $2,475.

If Modified Adjusted Gross Income combined with half of Social Security income adds up to $44,000 or more ($34,000 or above for single tax filers), 85% of Social Security benefits are subject to tax. So for somebody receiving $18,000 in Social Security benefits, $15,300 will be subject to income taxes at ordinary income tax rates. For someone in the 27.5% tax bracket, that could reduce the value of your retirement benefit by $4,207.

One Solution — Build Income in a Tax-Deferred Annuity
One way to reduce your taxable income is to have some of your investments in tax-deferred accounts. The earnings still belong to you, but unlike earnings in other taxable accounts, such as a bank certificate of deposit or money market account,* the earnings in tax-deferred annuities are not counted as income when determining whether you are subject to Social Security taxes.

For example, a couple earning 5% on a taxable CD with a principal value of $300,000 will have $15,000 in taxable income. If that would put their income over the threshold level by $2,000, they would owe taxes on their Social Security benefits. That could result in reducing their net, after-tax income significantly. By putting just $50,000 of their investment to work in a fixed annuity, rather than a CD, they could reduce their taxable income by $2,500, and avoid being subject to taxes on their Social Security income.

Please note that if your income threshold exceeds the limits described above, even by $1, you will owe taxes on a large portion of your Social Security benefits. So it pays to look at ways to reduce your taxable income for purposes of this critical calculation.

Build Wealth Without Boosting Your Tax Burden
If you have money earning taxable interest that isn't required to meet current income needs, it can also pay to shift it into a tax-deferred fixed annuity. Since the earnings are not currently taxable, you don't have to claim them as current income for the Social Security taxation calculation.

* CDs and bank money market accounts are insured by the FDIC. By contrast, fixed annuities are guaranteed by the claims-paying ability of the issuing insurance company.

Tax liability based on $9,000 of benefits subject to tax (50% column) and $15,300 of benefits subject to tax (85% column).

Content is for informational purposes only and may not accurately reflect your specific situation. Information is not intended to provide financial, legal, tax, or accounting advice. You should consult a qualified advisor for advice specific to your own circumstances.