How a Retiree With a $3 Million Roth IRA Can Get Away With Keeping 100% of Their Social Security Benefits
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The way to earn Social Security benefits in retirement is typically to work and pay FICA taxes on your wages throughout your career. If you earn enough credits (40 in your lifetime), you can typically qualify for Social Security once you turn 62.
You might think that because Social Security benefits are earned by paying taxes on wages, those benefits themselves would not be subject to taxes. But that’s not how the program works.
Social Security relies on taxes on benefits for revenue. That’s why the thresholds at which those taxes apply are very low and do not get an inflation adjustment.
It’s often the case that having a lot of income outside of Social Security makes it more likely that you’ll be taxed on your benefits. But if you have a $3 million Roth IRA, you may be able to collect Social Security without having any of those benefits taxed.
When taxes on Social Security apply
Whether you owe taxes on Social Security or not depends on something called your provisional income. It’s calculated as the sum of your adjusted gross income (AGI), tax-exempt interest income (such as municipal bond income), and 50% of the Social Security benefits you receive annually.
If you’re single and your provisional income is below $25,000, you shouldn’t face taxes on your Social Security benefits. But with a higher provisional income, taxes could apply. If you’re married filing a joint tax return, you need to keep your provisional income below $32,000 to avoid taxes on your Social Security.
How a Roth IRA could prevent Social Security taxes
If you have money in a traditional IRA, any withdrawals you take are added to your provisional income. And even if you choose not to take withdrawals, eventually, you’ll be forced to.
Once you turn 73 or 75, depending on your year of birth, you’ll have to start taking required minimum distributions (RMDs). RMDs, like any other traditional IRA withdrawals, count toward your AGI, which means you could see your provisional income rise to the point where you have to pay taxes on your Social Security benefits.
Roth IRA withdrawals, however, do not count toward AGI and therefore are not part of the provisional income formula. So let’s say you have $3 million in a Roth IRA and withdraw $100,000 per year. Let’s say you also get $4,000 a month in Social Security.
Half of your $48,000 in annual Social Security benefits is $24,000. But assuming you have no other income, that $24,000 is the only number that will go into your provisional income. So even with a large withdrawal from your Roth IRA, you could get to keep your Social Security benefits in full without taxes.
This is just one of many reasons why Roth IRAs are such a great retirement savings tool. Not only do they not impose RMDs, but investment gains and withdrawals are tax-free.
If you’re in the process of saving for retirement, you may want to choose a Roth IRA over a traditional IRA. While you won’t get pretax contributions with a Roth IRA, the benefits you stand to reap later on are worth giving that up.
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