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Client Success Stories: Spreading Income Over Two Years to Reduce Your Total Tax Bill Thumbnail

Client Success Stories: Spreading Income Over Two Years to Reduce Your Total Tax Bill

Folks are sometimes surprised to find out that Social Security benefits are taxable, like how salary is taxed as ordinary income at your highest marginal rate. But not all the benefit is taxable: depending on your other income, you may be taxed on as much as 85% of your Social Security benefit, or as little as 0%.

We recently encountered a client situation where we were able to solve a cash flow problem in a tax-efficient way by looking at more than just the current year, centered around the intricacies of how their Social Security benefits would be taxed. And while this specific situation may not apply to everyone, it’s indicative of how knowledge of how those benefits work can have a meaningful impact.

In this case, the client desired a specific amount of monthly income that up until a certain point had been funded with cash reserves. One spouse was approaching the age at which she planned on taking Social Security, which would allow her husband to claim a spousal benefit based on her work record (and allow his own benefit to grow at 8%/year until he claimed it).  

But Social Security wouldn’t be enough to meet their cash flow need. They would need some funds from their Individual Retirement Account (IRA) to supplement the shortfall over the remaining months of 2020 and all of 2021. This presented a challenge, since IRA withdrawals are taxable income, and each additional dollar that we withdrew would push the client closer to having more of their Social Security benefit subject to income tax.

Luckily, the partial year of Social Security benefits in 2020 didn’t amount to much income, and it was their only income source. This created some space for us to take more out of their IRA than they needed this year while still staying in a low tax bracket, and do it such a way that subjected their Social Security benefit to minimum taxation at most.

Using our tax planning software and some creative iterations on a spreadsheet, we were able to identify the optimal amounts to withdraw from the client's IRA in both 2020 and 2021 that would result in the least amount of Social Security being subject to taxes and the lowest total tax bill across both tax years. Any excess IRA withdrawals the client wouldn’t use in 2020 would stay in an after-tax brokerage account until the client started needing those funds in early 2021.

Not every client situation sets itself up well for a creative solution. But when it does, having the space and creativity to think a little out of the box can go a long way. If you have a cash flow situation that you’d like us to review, don’t hesitate to contact us!


(Photo by Unknown Author is licensed under CC BY-SA)

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