Roth Conversions and Taxes on Social Security

Look at this tax form:

$48,450 in Social Security and NO TAXES DUE!

In fact, if you look at line 8 you’ll see $25,700 of standard deductions.  Go down to line 15 and you see a big fat goose egg for taxes due. Thus, that $25,700 standard deduction has gone to waste, no?

Don’t Waste Your Standard Deduction?

One would then think this taxpaying couple should convert $25,700 to a Roth as that’d be tax free, right?

Oh, my ignorant friend, you have a lot to learn about the tax code. 🙂

In the next graph we convert $25,700 and guess what happens?


All we wanted to do was take advantage of the $25,700 of “wasted” standard deduction from the previous graph.   So, we converted $25,700 from our IRA to a Roth. We should still have NO TAX right???


IRA Distributions Make Social Security Taxable

The Provisional Income rules determine how much of your Social Security is subject to taxation.  These rules take ALL of your other income, to include tax-exempt interest, and if that income is above a certain threshold, you pay tax on your Social Security.  It’s literally that simple. 


In this case, that $25,700 in IRA distributions increased our taxable Social Security from 0 to $11,717 AND because we didn’t have enough income to pay the taxes we had to withdraw MORE from our IRA than we intended for the Roth Conversion. Thus with that $25,700 IRA distribution our taxable income became $38,218!

Ultimately, we paid $1,252 in income tax on a $25,700 distribution we thought would be tax free, an effective tax rate of  4.8%.   That may not seem like a big deal but just wait… it’s going to get a lot better, for the IRS that is. 


Why You Should Have a Taxable Account

But what if you have enough money in a brokerage or bank account to cover your spending  BEFORE you take Social Security? Things look a lot better. 

Graph 3 shows exactly why.

Note, with the $25,700 Roth Conversion we have just a SMALL amount of taxes due. And that’s just because the bank account, in this example, earned 1% interest on the $50,000. So, we had to pay a 10% rate on the $500 of interest earned. If that were LTCG or Qualified Dividends, we’d pay no tax. 

So, what’s the lesson here?  Try to avoid Roth Conversions when you’re taking Social Security!

The next post will show a married couple doing Roth Conversions after they’re taking RMDs. They’ll also be taking Social Security at that time.  Is it worth it? Stay tuned to find out.

© Copyright 2018 Heritage Wealth Planning