Reducing your taxable Social Security income can lower your future Social Security benefits. However, if you invest the tax savings into a side fund, you may come out financially ahead. By strategically balancing tax savings and investments, you can optimize your long-term financial security.
The Impact of Cutting Social Security Taxes
If you reduce the amount of income subject to Social Security taxes, you save money today but receive lower benefits in the future. The key to overcoming this tradeoff is to invest the tax savings into a well-structured side fund.
Example: Using an S Corporation or Partnership to Reduce Taxes
Let’s assume:
- Your taxable Social Security income is $168,600.
- You use tax strategies, such as forming an S corporation or a partnership, to cut your taxable Social Security income to 40% of that amount ($67,440).
- By making this change, you save $12,543.84 per year in Social Security taxes:
($168,600 – $67,440) × 12.4% = $12,543.84
Now, let’s look at how this impacts your future benefits.
Comparing Social Security Benefits With and Without Tax Savings
If you do not reduce your Social Security taxable income:
- You pay full Social Security taxes.
- Your Social Security retirement benefit at age 70 is $4,950.80 per month.
If you cut your taxable Social Security income to $67,440:
- Your Social Security retirement benefit at age 70 is reduced to $3,030.93 per month.
- However, if you invest the $12,543.84 tax savings annually at a 3% after-tax return for 35 years, you create a side fund that generates $3,785.47 per month for 20 years in retirement.
Total Monthly Retirement Income Comparison
Scenario | Social Security Benefit | Side Fund Benefit | Total Monthly Benefit |
Full Social Security Contributions | $4,950.80 | $0 | $4,950.80 |
Reduced Social Security Contributions + Side Fund | $3,030.93 | $3,785.47 | $6,816.40 |
By combining your lower Social Security benefit with your side fund, you increase your total monthly retirement income by $1,865.60.
However, if you do not set up a side fund, your total monthly income will be $1,919.87 lower than if you had paid full Social Security taxes.
Additional Benefits of Social Security
While cutting your Social Security taxable income reduces your retirement benefit, it does not affect other key Social Security benefits, including:
- Spousal Retirement Benefits – Your spouse can qualify for benefits as early as age 62, even if they have never worked.
- Medicare at Age 65 – Paying into Social Security ensures you qualify for Medicare coverage for life.
- Disability Benefits – Social Security provides financial protection in case of disability, offering support before retirement.
Dependent Benefits – Your minor or dependent children (including disabled children) may qualify for benefits—even after your death.
Key Considerations Before Cutting Social Security Taxes
1. You Need 40 Quarters of Coverage
- To qualify for Social Security retirement benefits, you must have at least 40 quarters (10 years) of covered earnings.
- If you reduce your Social Security contributions too much, you could risk disqualifying yourself from benefits.
2. Social Security Uses Your Highest-Earning 35 Years
- Your Social Security retirement benefit is based on your highest-earning 35 years.
If you cut contributions for too many years, it may significantly lower your final benefit calculation.
Takeaways
- Reducing taxable Social Security income lowers your future benefits—but investing the tax savings in a side fund can leave you financially ahead.
- A well-structured side fund can more than compensate for the reduced Social Security income, resulting in higher total retirement benefits.
- Reducing your Social Security taxes does not affect other key benefits such as Medicare, spousal benefits, or disability coverage.
- Be mindful of Social Security’s eligibility requirements, including the 40-quarter rule and the 35-year earnings rule.
By planning ahead and managing your tax strategies wisely, you can maximize your retirement income while still benefiting from Social Security’s additional protections.
