If you’re retired, your goal is probably to keep more of yourmoney rather than less. And part of that means adopting a smart financialstrategy.
Withdrawing from your retirement savings carefully, for example, could help keepyour tax bill lower, allowing you to hang onto more of your income. Similarly,reviewing your spending on a regular basis could help you avoid financial mistakes, such as wasting money onservices, subscriptions, or other things you don’t actually need.
But when it comes to Social Security, there’s a less obvious reason yourbenefits could shrink once you turn 73, and it’s important to be prepared forit.
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Why age 73 is significant for retirees
If you have your retirement savings in a traditional retirement account like anIRA or 401(k) plan, once you turn 73, you’ll have to start taking requiredminimum distributions, or RMDs. RMDs are calculated based on your accountbalance and life expectancy, and they can change every year.
RMDs are due each year by Dec. 31, though you can defer your first one to April1 of the year after you turn 73. If you don’t take an RMD when you’re supposedto, you risk a 25% penalty on whatever amount you do not withdraw by thedeadline. Missing a $4,000 RMD, for example, could mean facing a $1,000 penalty.
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How RMDs impact your Social Security benefits
You may be wondering what RMDs have to do with Social Security. To understandthe connection, it’s important to recognize the circumstances under which SocialSecurity benefits are taxed.
Social Security benefits are subject to taxes based on your provisional income.Provisional income is calculated as your adjusted gross income (AGI) plustax-exempt interest income you collect plus 50% of your yearly Social Securitybenefit amount. If your provisional income exceeds $25,000 as a single tax-fileror $32,000 as a married couple filing jointly, your Social Security benefitscould be taxed.
RMDs, meanwhile, count toward your AGI. If you’re forced to take withdrawalsfrom your savings that drive up your AGI, you could end up with a provisionalincome that’s high enough for your Social Security benefits to be subject tofederal taxes.
How to avoid getting taxed on Social Security benefits
If you don’t like the idea of having to pay taxes on your Social Securitybenefits, then there’s an important retirement savings decision to make whileyou’re building your nest egg — keep your money in a Roth account.
There are many benefits to having money in a Roth IRA or 401(k). First, gains inthese accounts are tax-free. Secondly, withdrawals during retirement are notsubject to taxes. Third, Roth accounts do not impose RMDs.
If you take a withdrawal from a Roth retirement account, it won’t count towardyour AGI. This means Roth withdrawals will not push you closer to owing taxes onyour Social Security benefits.
This isn’t to say that having money in a Roth IRA or 401(k) guaranteesthat your Social Security benefits won’t be taxed. You may have other incomestreams that drive up your AGI and provisional income. But with a Roth account,you won’t have to worry about RMDs causing your benefits to be taxed.
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You can still reduce your RMDs if you’re already retired
If you’re already retired and are collecting Social Security benefits, you maybe resigned to eventually having those monthly checks taxed once RMDs start. Butif you’re not old enough to have to take RMDs, you might still have anopportunity to get out of them or lower them.
If you’re able to do a Roth conversion, where you move money from a traditionalretirement plan to a Roth IRA, you may not have to take RMDs. Or, your RMDs maybe small enough that they don’t raise your provisional income to the point whereyou have to pay taxes on benefits.
Now one caveat is that the year you do a Roth conversion, you have to pay taxeson the amount you move into a Roth IRA. And that conversion could raise your AGIand cause you to owe taxes on your Social Security benefits. But it may be worthowing taxes on Social Security temporarily if it means getting out of themrepeatedly in future years.
Bottom line
A big part of your retirement plan is figuringout how to maximize your senior benefits and keep as much of your money as you can. So the less tax you have topay in total, the more retirement income you can enjoy.
It’s important to understand how RMDs could result in having to pay taxes onyour Social Security benefits. It’s also smart to choose your retirement savingsaccount carefully or look into a Roth conversion if the account you’re usingcurrently will leave you subject to RMDs once you get older.
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