Could Converting $7k Annually to a Roth IRA Increase Social Security Benefits?

Could Converting k Annually to a Roth IRA Increase Social Security Benefits?

Financial Advisor and Columnist Brandon Renfro

If we transfer more than $7,000 per year from a traditional IRA to a Roth IRA over the next four years (i.e. when we receive full Social Security), could this increase the amount that we receive social security? I realize we would pay taxes on this rollover, but I was wondering if it would increase our Social Security income starting in four years, while minimizing our taxable investment income from the Roth..

-Kathy

You are right, you need to include a Roth Conversion as part of your taxable income for a given year. However, converted assets are not considered income and therefore will not increase your potential Social Security benefit. In fact, Roth conversions can actually end up reducing the amount of your Social Security benefits you keep, although it seems like you can avoid this possibility.

A Financial Advisor can help you integrate both Roth conversions and Social Security benefits into an overall financial plan. Connect with a fiduciary advisor today.

Social security is based on covered income

A woman calculates her Social Security benefit amount using her phone.A woman calculates her Social Security benefit amount using her phone.

A woman calculates her Social Security benefit amount using her phone.

Your social security benefit full retirement age is calculated on the basis of the covered income you receive throughout your professional career. This includes salary, hourly wage, bonuses, commissions and self-employment income.

Sources of retirement and investment income are specifically excluded from the Social Security calculation of benefits. This includes Roth conversions.

At first glance, this may seem like you’re getting a bad deal. You pay taxes on that income, but you don’t get benefits in the form of higher Social Security benefits. However, keep in mind that retirement and investment income is not subject to FICA taxes, which are levied in addition to the regular income taxes you pay.

As a result, you end up paying less taxes on Roth conversions than on income earned. (If you have tax questions or need help optimizing your tax strategy, consider working with a financial advisor.)

How Roth Conversions Can Impact Your Benefits

How much your Social Security benefits are taxable depends on what's called your "combined income."How much your Social Security benefits are taxable depends on what's called your "combined income."

The taxable amount of your Social Security benefits is based on what is called your “combined income.”

Roth conversions won’t affect the calculation of your Social Security benefit you’re entitled to, but they may impact whether you pay taxes on your benefit — and how much. This is because your other income will partly determine how much of your Social Security benefit that you will need to include in your taxable income.

This measure of income is called your “combined income.” Calculating it is quite simple, you add up your adjusted gross income (AGI), half of your Social Security benefits, and any tax-free interest you may have.

Combined income = adjusted gross income (AGI) + tax-exempt interest + 1/2 of the social security benefit

The portion of your benefit that is taxable is then based on combined income thresholds. As a married couple filing a joint return:

  • None of your benefits are taxable if you and your spouse have a combined income of less than $32,000.

  • Up to 50% of your benefits are taxable if you and your spouse have a combined income between $32,000 and $44,000.

  • Up to 85% of your benefits are taxable if you and your spouse have a combined income of more than $44,000.

If you need help calculating how much you’ll pay in taxes on your Social Security benefits, speak with a financial advisor.

Examine your situation

You mentioned that you plan to make $7,000 worth of Roth conversions over the next four years, before you start receiving your Social Security benefits.

If so, this can actually help you reduce taxes on your Social Security benefits. Any conversion you make before your benefits begin reduces the amount of money you have in your tax-deferred accounts and, therefore, the taxable income those accounts will generate in the future. Since withdrawals from Roth IRAs are not taxable, they will not increase your combined income.

However, if you plan to continue making Roth conversions after you begin receiving Social Security benefits, keep in mind that this will add to your combined income and potentially increase the portion of your benefits subject to tax. (As you can see, tax planning can be complicated, which is why you may benefit from work with a financial advisor.)

Conclusion

Social Security benefits are based on your income, which is not exactly the same as your taxable income. Taxable income that is not subject to FICA, such as Roth conversion amounts, will not increase your benefits. However, increasing your taxable income while you collect Social Security can increase the percentage of your benefits on which you will pay taxes. This doesn’t mean you should always avoid doing a Roth conversion if you already have Social Security. This simply means that you must consider the full effect of the strategy.

Social Security Planning Tips

  • Remember that the age of your claim will affect the amount of your benefits for the rest of your life. Applying at age 62 can result in a benefit reduction of up to 30% compared to waiting until full retirement age. Likewise, delaying Social Security until age 70 can increase your benefit by up to 32%. Smart assets Social Security Calculator can help you estimate the amount you can receive based on when you make your request.

  • A financial advisor can assess your overall financial situation and help you determine when to potentially qualify for Social Security. Find a financial advisor It doesn’t have to be difficult. The free SmartAsset tool connects you with up to three approved financial advisors that serve your area, and you can have a free introductory call with your advisor to decide which one seems best for you. If you are ready to find an advisor that can help you achieve your financial goals, start now.

Brandon Renfro, CFP®, is a financial planning columnist for SmartAsset and answers reader questions on topics related to personal finance and taxes. Do you have a question you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Brandon does not participate in the SmartAdvisor Match platform and was compensated for this article. Some reader-submitted questions are edited for clarity or brevity.

Photo credit: ©iStock.com/RichVintage, ©iStock.com/MariuszBlach

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