Ask an Advisor: Could $7k Roth IRA Conversions Increase My Social Security Checks?

If we roll over $7,000 per yr from a traditional IRA to a Roth IRA for the next four years (which is when we will receive full Social Security), could it bump up the amount that we receive in Social Security? I realize that we would pay taxes on that rollover, but I was wondering if it would boost our Social Security income starting in four years, while minimizing our taxable investment income from the Roth.

– Kathy

You are correct that you must include a Roth conversion as part of your taxable income for a given year. However, converted assets aren’t considered earnings so they won’t increase your eventual Social Security benefit. In fact, Roth conversions can actually end up reducing how much of your Social Security benefit that you keep, although it sounds like you may avoid that possibility.

A financial advisor can help you you incorporate both Roth conversions and Social Security benefits into a holistic financial plan. Connect with a fiduciary advisor today.

Social Security Is Based on Covered Earnings

Your Social Security benefit at full retirement age is calculated based on the covered earnings that you receive throughout your working career. This includes salary, hourly wages, bonuses, commissions and self-employment earnings.

Sources of retirement and investment income are specifically excluded from the Social Security benefit calculus. That includes Roth conversions.

At first blush, that may seem like you are getting a raw deal. You pay taxes on that income, but then you don’t get the benefit in the form of higher Social Security benefits. However, keep in mind that retirement and investment income isn’t subject to FICA taxes, which are levied on top of the regular income taxes you pay.

As a result, you end up paying less in taxes on Roth conversions that you do on earned income. (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

Roth conversions won’t affect the calculation of your Social Security benefit that you’re eligible to receive, but they can impact whether you pay taxes on your benefit – and how much. That’s because your other income will determine in part how much of your Social Security benefit you’ll have to include in your taxable income.

This income measure is called your “combined income.” Calculating it is fairly straightforward. You add together your adjusted gross income (AGI), half of your Social Security benefit and any tax-free interest that you may have.

Combined Income = adjusted gross income (AGI) + tax-exempt interest + 1/2 of Social Security benefit

How much of your benefit 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 over $44,000

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

Examining Your Situation

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

If so, this can actually help you reduce taxes on your Social Security benefits. Any conversions you do before your benefits begin reduce the amount of money you have in tax-deferred accounts, and in turn, the taxable income those accounts will generate down the road. Since withdrawals from Roth IRAs aren’t taxable, they won’t increase your combined income.

However, if you plan to continue doing Roth conversions after you begin collecting Social Security benefits, remember that it will add to 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.)

Bottom Line

Social Security benefits are based on your earnings record, which is not exactly the same as your taxable income. Taxable income that isn’t subject to FICA, like 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 that you’ll pay taxes on. That doesn’t mean you should always avoid doing a Roth conversion if you’re already receiving Social Security. It just means you need to consider the full effect of the strategy.

Social Security Planning Tips

• Remember that your claiming age will impact how much your benefits for the rest of your life. Claiming 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%. SmartAsset’s Social Security calculator can help you estimate how much you may collect based on when you claim.

• A financial advisor can assess your overall financial situation and help you determine when to potentially claim Social Security. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

• Keep an emergency fund on hand in case you run into unexpected expenses. An emergency fund should be liquid — in an account that isn’t at risk of significant fluctuation like the stock market. The tradeoff is that the value of liquid cash can be eroded by inflation. But a high-interest account allows you to earn compound interest. Compare savings accounts from these banks.

Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email [email protected] and your question may be answered in a future column.

Please note that Brandon is not a participant in the SmartAsset AMP platform, nor is he an employee of SmartAsset, and he has been compensated for this article. Some reader-submitted questions are edited for clarity or brevity.

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