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How to Avoid Paying Taxes on Social Security Income

Updated on April 22, 2014

Created over 75 years ago, Social Security was originally designed to help senior citizens avoid poverty during the Great Depression. It was created as a self-financing program that would collect payroll taxes from workers which would immediately be paid out in benefits to retirees.

Today, millions of Americans depend on Social Security as their primary source of retirement income.


The Social Security Excise Tax

Unfortunately, our government feels that you are rich if you make over $34,000 as an individual or $44,000 as a couple. In fact, the IRS adds up to 85% of an individual's Social Security benefits plus all other income (such as pensions, CD/bond interest or capital gains) to calculate the income taxes owed. It’s important to know that deferred annuity & life insurance interest is not included in the year it is earned. It is only included in the year it is withdrawn. By re-positioning your assets into annuities & life insurance you can defer the interest earnings until you choose to withdraw them, you could save thousands and thousands of dollars in taxes. You’ll be able to defer income taxes on your interest earnings and reduce or eliminate income taxes on your Social Security benefits – a double win.

Split Annuity vs. Taxable Investment

Let me tell you a story about Mike and Cindy Johnson. Mike turned 66 and retired. Between Mike's social security benefit and his retirement, Mike's retirement income totaled under $32,000 keeping his income just under the limit and paying no taxes on his social security. Then one day Mike got a phone call that he had inherited $400,000 from his Aunt. Mike took his inheritance and invested the money into a mutual fund earning a promised 5% return. At the end of the year Mike had earned $20,000 from his investment. By the time he paid federal tax on his earnings, he was left with just $15,000, but Mike wasn't expecting what was about to happen next. These earnings caused Mike to have to pay taxes on his social security benefit too. After deducting the taxes on his social security benefit, Mike is now left with $10,750. That is a 46.25% tax bracket!

What Mike should have done was purchase a split annuity. A split annuity is the combination of an immediate annuity and a fixed indexed annuity. By dividing the money into these two annuities, Mike could have enjoyed an annual payout of $18,000 of which only $2,520 is taxable resulting in only $388 in taxes. At the end of the 10 year period, the immediate annuity will have run out and he fixed indexed annuity will have grown back to the original $400,000. Mike enjoyed $6,872 more net income than the mutual fund, tax bracket reduced from the 25% tax bracket down to the 15% tax bracket, and eliminated paying taxes on his social security benefits.

This is where I take a bow and thank you very much.


Were you aware of the Social Security Excise Tax?

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