CUT YOUR SOCIAL SECURITY

Many retirees are dismayed to learn that they owe taxes on a portion of their benefits. But you can take steps to minimize the pain.

- SANDRA BLOCK

After decades of having Social Security taxes withheld from your paycheck, you may not expect to pay taxes on the benefits you've earned. But if you have other sources of income, such as a job, a pension or withdrawals from tax-deferred retirement savings plans, there's a good chance you'll pay taxes on up to 85% of your benefits. Depending on where you live, your state may tax your benefits, too (see the box on page 82).

The government started taxing a portion of Social Security benefits 40 years ago as part of an overhaul designed to shore up the program's finances. Legislation signed by President Ronald Reagan in 1983 imposed taxes on up to 50% of benefits if a retiree's income exceeded specific limits. Ten years later, President Bill Clinton signed legislation that made up to 85% of benefits taxable for retirees whose earnings exceeded a second income threshold.

FIGURING THE TAX BITE 

The formula is based on what Social Security defines as a beneficiary's provisional income, sometimes referred to as combined income. Your provisional income is based on half of your Social Security benefits, plus other sources that contribute to your adjusted gross income, including wages from a job, withdrawals from traditional tax-deferred accounts, and dividends, interest and capital gains from taxable investment accounts. Interest from municipal bonds, which is generally tax-free, is also included when calculating your provisional income.

If your provisional income ranges from $25,000 to $34,000 for single filers, or $32,000 to $44,000 for joint filers, up to 50% of your benefits will be taxable. If your provisional income is more than $34,000, or $44,000 for joint filers, up to 85% of your benefits will be taxable (see the box below).