Adding IRA and 401(k) distributions to retirement income can be an effective strategy for seniors to enjoy their golden years, but the combination can also impact Social Security benefits in some cases.
For example, distributions from a traditional IRA or 401(k) are counted as ordinary income by the Social Security Administration (SSA) and included in adjusted gross income (AGI) calculations.
The SSA includes factors in all taxable income sources, such as wages, dividends, capital gains, business income, and distributions from traditional IRAs and 401(k)s when determining a claimant’s AGI.
"While AGI doesn’t reduce your Social Security benefit amount directly, it does determine how much of your benefit is taxable and whether you’ll face higher Medicare premiums,” Falcon said.
Distributions from Roth IRA accounts, however, do not trigger Social Security or Income-Related Monthly Adjustment Amount (IRMAA) taxation.
That’s because Roth IRA holders have already paid taxes on those savings.
“Only the taxable distributions from traditional IRAs are included in the provisional income calculation that determines the taxes on Social Security benefits,” Florida-based independent investment adviser Aaron Brask told NTD.
The IRMAA is a monthly charge in addition to the Medicare Part B premium and is based on income from two years prior.
A large IRA withdrawal can bump a beneficiary into a higher tax bracket and cost hundreds or even thousands more per year, according to Equanimity-Wealth.com certified financial planner Michael Rodriguez in Los Angeles.
“Tools like Qualified Charitable Distributions or gradually converting traditional IRA assets to a Roth in lower-income years can help manage your future income levels,” Rodriguez told NTD.
While Qualified Charitable Distributions (QCDs) are tax-free withdrawals from an IRA made directly to a charity, provisional income is a calculation the SSA uses to determine how much, if any, of a claimant's benefits will be taxed.
Only up to 85 percent of a retiree’s Social Security benefit can be taxed.
“An IRA triggers taxes on a retiree's social security income when the distribution is high enough to increase their provisional income above the relevant thresholds," Brask said. “You calculate provisional income by adding half of your Social Security benefit."
As a result, Falcon sees Roth accounts as powerful tools in retirement income planning.
“The key is managing your combined income, which might mean drawing from Roth accounts or taxable brokerage accounts first, using QCDs to satisfy RMDs without increasing AGI and spreading out large withdrawals over multiple years,” he said.