IRA Roth IRA Social Security

Want to Reduce Taxable Social Security Benefits? Consider a Roth IRA Conversion

When deciding whether or not to do a Roth IRA conversion, keep in mind the impact of your decision on the taxation of your Social Security benefits.

Last week’s post, Reduce or Eliminate Your Required Minimum Distributions With a Roth IRA Conversion was a precursor to this week’s topic. It explained how a Roth IRA conversion can be used to reduce, or potentially eliminate, required minimum distributions (“RMD’s”). It also illustrated the growth potential of a distribution-free IRA vs. one that is subject to RMD’s.

In addition to achieving greater growth through a reduced distribution or distribution-free IRA, a Roth IRA conversion can also reduce your taxable Social Security benefits. To the extent that a Roth IRA conversion reduces the amount remaining in your traditional IRA, your RMD’s will be reduced since they are based on the value of your traditional IRA as of December 31st of the preceding year. When you reduce RMD’s, you reduce income that is used in the calculation of taxable Social Security benefits, assuming that you don’t replace your previous RMD income with other taxable income.

The amount of one’s income and filing status determine the amount of taxable Social Security benefits. For this purpose, income includes tax-exempt interest income and 50% of Social Security benefits in addition to all other items of income normally included in the calculation of adjusted gross income. If the resulting total exceeds specified base amounts ($25,000 for single and head of household and $32,000 for married filing jointly), then at least 50%, and up to 85%, of Social Security benefits are taxable.

The easiest way to illustrate the impact of RMD’s vs. no RMD’s on the taxation of Social Security benefits is with an example. Per the attached Taxable Social Security Benefits Example, all facts are identical with the difference being that Case A includes taxable IRA’s, or RMD’s, in the amount of $18,000 vs. $0 in Case B. Case A provisional income of $50,000 exceeds the base amount of $32,000, resulting in taxation of Social Security benefits. $11,100, or 55.5% of Social Security benefits, are taxable. Case B provisional income of $32,000 is identical to the base amount, resulting in no taxation of Social Security benefits.

While the amount of your income excluding RMD’s may be in excess of the Social Security base amount, resulting in taxation of your Social Security benefits, you may be able to reduce the percentage of your taxable Social Security benefits below 85%, and possibly as low as 50%, by reducing your RMD’s via one or more Roth IRA conversions. This can result in significant income tax savings for many years.

When deciding whether or not to do a Roth IRA conversion, as well as the amount of same, whether you’re 40 years old or 70 years old, always keep in mind the impact of your decision on the potential taxation of your current and/or future Social Security benefits.

By Robert Klein

Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. Bob is also the sole proprietor of Robert Klein, CPA. Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies to optimize the longevity of his clients’ after-tax retirement income and assets. He does this as an independent financial advisor using customized holistic planning solutions based on each client’s needs and personality.