Provisional Income

Even though you've already paid income taxes on the earnings you've contributed to Social Security over the years, when you receive your benefits, they too may be subject to income tax. By knowing how much income you may earn before your Social Security benefits become taxable, and by using a few strategies, you may be able to ease the tax on your benefits.

The amount of Social Security benefits you have to include in your gross income depends on your "provisional income." The key to reducing taxes on your Social Security benefits, then, is to take steps to reduce your provisional income.

Shift your investment focus. Many Social Security recipients are retirees who are income-oriented investors. Shifting some assets to growth-oriented stocks may be one way to reduce provisional income, since any unrealized appreciation wouldn't be taxed until the investments were sold. Be aware that transferring assets from one mutual fund to another is a taxable event and that investing with taxes in mind is only one element of a sound investment strategy.

Make gifts of income-producing assets. In addition to the benefit of lowering your provisional income, giving selected assets to your children or to a qualified charity could also provide you with some estate- and gift-tax benefits.

Eliminate debts. Some investors incur debt while remaining fully invested. By paying off debts with funds that are earning interest or dividend income, your provisional income will be reduced.

Invest in tax-deferred annuities. With a tax-deferred annuity, you invest a sum today and your investment earnings are not taxed until distributions are paid out later. Thus, your provisional income is not increased by the deferred earnings.

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