Author Topic: Taxes, Roth conversions when SS starts  (Read 3230 times)

quilter

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Taxes, Roth conversions when SS starts
« on: July 20, 2014, 05:19:07 AM »
So as planners we run a lot of what if scenarios. We have been converting to roth's slowly, keeping in mind the tax rate.   We have no earned income, just 401 and now that we are 59 1/2 + can access the Roths too.

As we approach SS we arerunning scenarios on who should start when. But one thing is not clear. When you get SS is that counted towards your income for tax purposes when you have no earned income?  In other words, we want to convert as much of the Roth money as we can at 15%, but some at 25% may be OK.  I can't imagine taxes won't rise in the future given the overall picture of the spending and future liabilities of government regardless of who is in office so we are trying to be as logical as possible while doing everything legally.

I just got Ed Slott's latest book as well.  Hopefully that will help with our planning.

Catbert

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Re: Taxes, Roth conversions when SS starts
« Reply #1 on: July 20, 2014, 01:33:43 PM »
http://www.irs.gov/uac/Publication-915,-Social-Security-and-Equivalent-Railroad-Retirement-Benefits-2

Taxing of social security is complicated.  I suggest reading the above linked IRS publication.  Up to a certain level SS isn't taxed.  If you otherwise earn enough up to 85% of SS is taxed at regular income tax rates.  Try to do as many conversion as possible before you collect on SS.     

quilter

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Re: Taxes, Roth conversions when SS starts
« Reply #2 on: July 21, 2014, 05:21:12 PM »
Thank you Mary. I had already read those pages trying to make sense of it all. I think we are going to print out a tax form and put on paper possible scenarios to figure it out. I cannot believe how complicated it is, and we are pretty smart people.

Catbert

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Re: Taxes, Roth conversions when SS starts
« Reply #3 on: July 21, 2014, 05:40:22 PM »
Try using one of the on-line tax prep software like Turbotax.  Input a projected income including SS and see what happens.  My income is such that 85% of DHs SS is taxed so I haven't had to figure out all the ins and outs.  If you think that you'll escape that then definitely figure it out now before collecting.  If you're at the point that each dollar of Roth conversion means that one more dollar of SS is taxable then it may not be worth doing conversions that year.  Even at the 15% marginal rate you'll pay 15% tax on the conversion, then 15% of 85% SS above the threshold which makes it really almost a 30% rate.

 

Neva More

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Re: Taxes, Roth conversions when SS starts
« Reply #4 on: July 28, 2014, 10:31:20 AM »
Hi Quilter, I'm glad you like to plan and run different scenarios because  there is a lot Of variables deciding when to start SS.  I became exposed to taxation and SS in 1996 when my Dad was ill and needed me to complete his taxes. He had the same income basically as my DH and I and paid a federal tax bill of $265 dollars while our tax bill was  $4500. What an eye opener.

  To answer your question Social Security is counted as income and in the 1040 booklet there is a worksheet  entitled "Social security benefits worksheet-line 20a and 20b"
If you don't have a 1040 booklet  you can get this from irs.gov. it is a little confusing at first but I will try to give you an example. There is plenty of information coming out now on maximizing  social security for couples and holding  till age 70 to collect but this creates a tax torpedo (meaning a huge tax bill) when combine with required minimum distributions from a 401k or tax deferred IRA. Say one of you qualified for the max in SS at 66 and the other one of you was going to take spousal at 50% so that would be roughly $45,000 and if you take it at 62 it would be reduce by 25% to $33750. A good amount for a frugal couple! but if you wait for four years you will forgo getting a total of $135,000 and you will need to get your expenses from savings and Pay taxes on your Roth conversion too, also reducing your stash.  So plugging in the $33,750, is line 1 into the worksheet. One half of it, Line 2 would be $16875. I did the math behind getting a zero tax bill and you could do a Roth conversion of $18,400 on line three for a total of $35,275 on line 5. Line6 as zero. So line 7 would be also $35,275. subtract $32,000 from this and you have $3,275 left and  this is less then the extra $12,000 as a married couple so one half of that rounded is $1638 and this is the amount of your social security that is taxable which would go on 1040 form, line20b. Add this to your $18,400 for a total of $20,038 which is slightly less then 2014 standard deduction and personal exemptions for a tax bill of zero.  So the total income between the SS $33750and $18,400 is $52,150. If like you said your only other taxable money is the Roth conversions using the social security worksheet you could pay zero taxes  total on Social Security and a Roth conversion of $18,400. If you want to you could increase the Roth conversion up to $27,125 and still be only in the 10% tax bracket and pay roughly $1382 total federal tax bill if you use the standard deductions.  So by the time you got to age 70 the $1382 or less taxes per year alternative would have  a Roth balance of more then $217,000 and choosing the zero tax scenario you would have a balance of $147,000 plus earnings. Any of these earnings and the contributions per each can be touch on Jan 1 of the fifth year after the individual contribution. Any 2014 conversion on Jan 1, 2019 tax free,2015 conversion on Jan 1, 2020,etc. See Ed Slott site for further details on this.
     I don't know how large your tax deferred 401k or IRA is but the next step is to find out what the minimum distributions will be when you turn 70 1/2 and beyond. I use Fidelity's minimum required distribution calculator and put your birthday year as 1944 and your current balance. Look at all of the yearly projections usually maxes out in your late eighties. I use 4%,5%, 6% as my assume rate of return to get different charts or plug in your ten year average if you want to be more accurate. You can then compare the yearly figures to the two figures of $18,400and $27,125 to see if you will be taking enough out before you reach 70 1/2 to eliminate the huge tax bill that comes when you have to take required distributions. The huge tax bill comes because 85% of your SS becomes taxable and this is added onto the RMD pushing you into a much higher tax bracket. I found after doing all the figures I was way ahead taking SS early and the Roth conversions. I hope this helps you. Sincerely, Neva More as in neva more will I have to work!

quilter

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Re: Taxes, Roth conversions when SS starts
« Reply #5 on: July 28, 2014, 06:06:57 PM »
Thank you Neva more. Your calculations are what we have been trying to do. We are not stupid people but fine it very complicated

I hope your wish comes true and you Neva more have to work soon

Neva More

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Re: Taxes, Roth conversions when SS starts
« Reply #6 on: July 28, 2014, 07:17:02 PM »
Thanks for your wish and it has come true I have been early retired for sixteen years. If I can help you in any other questions feel free to post it. I looked over  my last post and the 27,125 figure is the max where 1/2 the social security and Roth conversion  totals the $44,000 so only $6000 of the SS is taxable. I did't think you were stupid I just know how hard it is to understand and I was lucky enough to have a great instructor, My Dad to walk me through it and I was paying it forward. Sincerely,Neva