How IRAs Impact Social Security

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In many cases, traditional IRAs impact Social Security benefits by increasing your taxable income. Having a solid plan for your IRA distributions can save you thousands of dollars, so it's worth understanding how these two pillars of retirement planning work together.

Combining Social Security benefits and an IRA can be an effective strategy for funding your retirement. However, if you take a distribution from a traditional (not Roth) IRA, you may have to pay taxes on your Social Security benefits. This can certainly have a major impact on your retirement income.

So, let’s take a deeper look at how this works.

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Up to 85% of your Social Security benefits are subject to federal income taxes. This is based on your “combined income,” or your adjusted gross income (AGI) plus nontaxable interest and half of your annual Social Security benefits. You will include the amounts from your spouse if you file jointly.

As for the AGI, it includes wages, interest, investment income and distributions from traditional 401(k)s and IRAs. You can then make adjustments, such as for a health savings account (HSA) and other calculations that may change your AGI.

Here are the tiers of taxes due on Social Security benefits for individuals and couples filing jointly.

If your combined income is under $25,000 (single) or $32,000 (married filing jointly), your Social Security benefits are not taxed.
For combined income between $25,000 and $34,000 (single) or between $32,000 and $44,000 (married filing jointly), up to 50% of your benefits may be taxed.
For combined income above $34,000 (single) or above $44,000 (married filing jointly), up to 85% of your benefits may be taxed.

Let’s consider an example. Suppose you and your spouse are retired. Your combined Social Security benefits are $35,000 and you take an IRA distribution of $35,000.

Half of the Social Security benefits is $17,500, which you then add to the IRA distribution for a total of $52,500 in combined taxable income. Remember, however, that while this amount is above the threshold for being taxed as much as 85% of the benefits, this does not necessarily mean you will pay at this level. This is the maximum. You can use Worksheet 1 from IRS Publication 915 to calculate your taxable benefits. But this is a complex area and it is a good idea to seek the help of a tax expert or use tax software.

However, if you had not taken an IRA distribution, then the Social Security benefits would have been tax-free.

Another issue with an IRA withdrawal is that it can push you into a higher Medicare Income-Related Monthly Adjustment Amount (IRMAA) bracket. “This increases your Medicare premium,” said Marcus Holzberg, a certified financial planner™ at Holzberg Wealth Management. “Since Medicare is deducted from your Social Security check, this will inadvertently reduce your Social Security benefits.”

Despite what you may have heard, the Social Security Administration does not count IRA distributions as earned income when determining Social Security payments. The same goes for pension payments, annuities or interests and dividends from savings and investments. None of that will lower your monthly benefits although it can cause a taxable event if your AGI increases as a result.

Required minimum distributions (RMDs)

To avoid taxes on your Social Security benefits, you can defer making distributions from your IRA. This also has the benefit of allowing your money to grow.

But there is a limitation: required minimum distributions (RMDs). This is when you must make withdrawals from your traditional IRA or other pre-tax retirement accounts like a Simple IRA, SEP IRA, 401(k) and 403(b). The amount is considered income for the taxes on your Social Security benefits.

RMDs are triggered based on your age, ranging from 73 to 75. The amount of the withdrawal is based on a calculation from the IRS, which includes the account balance and your life expectancy. If you do not make the distribution, you will be subject to paying income taxes and a 25% penalty.

One way to deal with the impact of RMDs is by taking a qualified charitable distribution (QCD). “This allows you to use distributions from your IRA to contribute directly to qualified charities,” said Holzberg. “In doing this, the IRA distribution is not included in your income, thereby lowering your AGI.”

On the other hand, you can delay when you claim Social Security benefits. You can wait until age 70. For every year you delay receiving the benefits, your annual payment increases by about 8%.

Tom Taulli has been developing software since the 1980s when he was in high school. He sold his applications to a variety of publications. In college, he started his first company, which focused on the development of e-learning systems. He would go on to create other companies as well, including Hypermart.net that was sold to InfoSpace in 1996. Along the way, Tom has written columns for online publications such as Bloomberg, Forbes, Barron's and Kiplinger. He has also written a variety of books, including Artificial Intelligence Basics: A Non-Technical Introduction. He can be reached on Twitter at @ttaulli.

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