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George Saenz, the Bankrate.com Tax Talk columnistMinimizing Social Security taxes

Dear Tax Talk,
We are both retired. Have good savings for the region in which we live. I work part-time in order to have the extras. Last year over half of our Social Security benefits were taxed and we were not happy with what we had to pay in. What kind of shelter should we be looking at?
-- Bee

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Dear Bee,
Nobody's happy about paying taxes, but people are usually happy about saving taxes, and that makes me happy and busy. As you probably found out the hard way, Social Security benefits are taxable if your income exceeds a base amount. Although Uncle Sam gives you your benefits gladly, his other hand is there waiting to take it back.

It used to be that only up to one-half of benefits were considered income for those exceeding the threshold. The theory was that since Social Security came one-half from your contributions and one-half from your employer's, it was right to tax the benefit provided by the employer's contributions. That theory went out the window when they made up to 85 percent of benefits taxable.

How it works:

The base amount, for purposes of taxing Social Security only, includes amounts you receive on tax-free bonds, such as state and local bonds. Therefore, investing in tax-frees will not allow you to escape paying tax on your benefits. Some alternative strategies would be to limit or time your income from year to year.

For example, you could invest in CDs that mature every other tax year so all the income from the CDs is grouped in that year, allowing you to reduce your income in intervening years and avoid taxation of benefits. Also, if you are not required to take minimum IRA distributions (i.e., you are not age 70½), either defer their receipt completely or group the distributions every other year if you need the funds.

Similar considerations should apply to gains from the sale of stocks or properties. Although you may not get out of paying tax on your benefits every year, if you can do it every two years, that should give you something to smile about.

To ask a question on Tax Talk, go to the "Ask the Experts" page and select "taxes" as the topic.

Bankrate.com's corrections policy -- Posted: Sept. 14, 2006
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