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If we transfer more than $7,000 per year from a traditional IRA to a Roth IRA over the next four years (which is when we will receive full Social Security), would this be the can we increase the amount we receive in social security? I realize we would pay taxes on that transfer, but I wondered if this would increase our Social Security income over four years while minimizing our taxable Rothschild investment income..
– Kathy
You are correct in saying that you should include a Roth conversion in your taxable income for a given year. However, converted assets are not considered income and therefore do not increase any Social Security benefits you may receive. In fact, Roth conversions can cause you to reduce the portion of your Social Security benefit you keep, although it may seem like you might avoid that possibility.
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A woman uses her phone to calculate how much her Social Security benefits will be.
Your Social Security benefit at full retirement age is calculated based on the covered income you receive throughout your career. This includes salary, hourly wages, bonuses, commissions and self-employment income.
Sources of retirement and investment income are specifically excluded from the calculation of Social Security benefits. That includes Roth conversions.
At first glance, it may seem like you’re getting a raw deal. You pay tax on that income, but then you do not receive the benefit 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 charged on top of the regular income taxes you pay.
As a result, you end up paying less taxes on Roth conversions than on earned income. (If you have tax questions or need help optimizing your tax strategy, consider working with a financial advisor.)
How much of your Social Security benefit is taxable is based on what’s called your “combined income.”
Roth conversions don’t affect the calculation of your Social Security benefits for which you qualify, but they can affect whether you pay taxes on your benefits – and how much. That’s because your other income partly determines how much of your Social Security benefit you must include in your taxable income.
This income measure is called your “combined income.” Calculating it is quite simple. You add up your adjusted gross income (AGI), half of your Social Security benefit, and any tax-free interest you have.
Combined income = adjusted gross income (AGI) + tax-free interest + 1/2 of Social Security benefit
How much of your benefit is taxable is then based on the joint income limits. If a married couple files a joint tax 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 joint 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, contact a financial advisor.
You said you plan to make $7,000 in Roth conversions over the next four years before you start receiving your Social Security benefits.
If so, it can actually help you reduce taxes on your Social Security benefits. Any conversion you make before your distributions begin reduces the amount of money you have in tax-deferred accounts, and in turn, the taxable income those accounts will generate later. Because withdrawals from Roth IRAs are not taxable, they will not increase your combined income.
However, if you plan to make Roth conversions after you start collecting Social Security benefits, keep in mind that this will increase your combined income and potentially increase how much of your benefits are subject to taxes. (As you can see, tax planning can be complicated, which is why you may benefit from working with a financial advisor.)
Social Security benefits are based on your income information, which is not exactly the same as your taxable income. Taxable income not subject to FICA, such as Roth conversion amounts, will not increase your benefits. However, if you increase your taxable income while collecting Social Security, the percentage of your benefits on which you pay taxes may increase. That doesn’t mean you should always avoid a Roth conversion if you’re already receiving Social Security. It just means that you need to consider the full effect of the strategy.
Keep in mind that your claiming age affects the amount of your benefit for the rest of your life. Filing at age 62 could 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 benefits by up to 32%. SmartAsset’s Social Security Calculator can help you estimate how much you can collect based on when you file a claim.
A financial advisor can assess your overall financial situation and help you determine when you might be able to claim Social Security. Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can have a free introductory meeting with your advisors to decide which one you think is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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Brandon Renfro, CFP®, is a financial planning columnist at SmartAsset, answering reader questions about personal finance and tax topics. Do you have a question that you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAsset AMP platform, nor an employee of SmartAsset, and has received compensation for this article.Some reader-submitted questions have been edited for clarity or brevity.
