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Roth, Traditional or Taxable Savings? —
Social Security & Taxes

Most of you know about the various tax advantaged retirement accounts, the 401.(k), traditional IRA and Roth IRA (as well as the newer Roth 401.(k). There are resources all over the place that talk about all of these retirement accounts. There are also taxable accounts where you pay taxes on the interest and distributions year by year.

Having just gone through my first year having started receiving my reward for reaching 62, I began taking my reduced Social Security benefit. Since I saved and scrimped all my working life, I also had a nest egg of a traditional IRA, some Roth IRA and the rest in taxable savings and investment accounts.

I knew that I was limited to around $14,500 or so in earned income before they would subtract my social security benefit. There was not much danger of that happening as my earning days were pretty much over. But I always knew this rule as it mentioned quite often. Social Security was for after you finished working.

Being a lower income person, I was able to realize capital gains and qualified dividends at a 0% Federal tax rate. (Thank you G.W. Bush) It was a simple matter to keep track of my income during the year. I would wait for the estimated capital gain distributions to be announced, and then I would know how much more to take in capital gains. I was truly able to game the tax system, legally of course. I did have to pay New York State income tax though.

The taxable income I could have was about $35,000 before leaving the 15% bracket (with 0% for cap gains). Then the exemptions would be added in as well as the standard or itemized deductions. This would end up being in the mid $40k. I file as a single. Married is a lot higher.

So everything was just ducky. I could realize gains without tax, so I would boost the amount of realized gains for the free ride.

In late 2012, I found out that if someone was filing New York State tax and over 59-½ years old, the first $20,000 of pensions or traditional IRA distributions were not taxed! This is the first time that the state ever threw me a bone, as someone that has $20k taxable income pays the highest regular rates. There are income limits too on the state, so check out the whole story on this.

With the state, one could also convert a traditional IRA to a Roth IRA and the first $20,000 would not be taxed by the state, only the feds. I never liked that tax dagger hanging over my head, with the required minimum distributions at age 70-½. As soon as the Roth IRA became available, that was where I always funded my retirement.

I suppose if you are in the highest bracket the traditional IRA is a pretty good deal for you. But is it really? This is the point of this web page.

There was another Social Security shoe that was about to drop. This is something that I never realized. I actually read this when I was applying for Social Security, but it didn't register. It actually is a little unbelievable. That is, at fairly low income levels up to 85% of your Social Security income is subject to regular income tax!

The levels are as follows: If your Modified Adjusted Gross Income (MAGI) plus half of your Social Security benefit is over $25,000 (for singles, $32k married), the amount over $25,000 starts to be taxed at your regular tax rate for up to half of your Social Security money. If the amount is over $34000 (again single), then up to 85% of the money you received is taxable. What also rubs the salt in the wound is this amount isn't raised for inflation each year. I have no idea how long that $25k level has been the law of the land.

In these situations, this income (half or 85% of your Social Security money) is added on top of your other income. It is possible that you would be pushed to a higher bracket too. Please read up on this yourself as there are better explanations out there. You can then work a sample tax form and you will see what happens. There is a worksheet involved in this process.

If you have a traditional IRA that you touch, either for conversion to an IRA or that you want to spend it, or the RMD is nipping at your heels, this amount is added on top of other income plus half or 85% of your taxable Social Security to give you a final amount.

If you have $10,000 in your regular (taxable) savings account, you can take that money and spend it without adding to your MAGI and the income tax. If you have a Roth IRA (or the new Roth 401.(k)), there is no tax on those distributions either.

My point is that perhaps this traditional IRA (or 401.(k)) is not the good deal that you think it is. I think that a Roth IRA or Roth 401.(k) is the truly good deal! You pay the taxes now for a completely tax free future of that money, including if it goes to your heirs. There is no jacking up of the taxable income either.

It is kind of too late for me, except for Roth IRA conversions. I have worked out a plan of a combination of realizing capital gains and Roth conversions up to the $34,000 limit. Yes, half of my Social Security is subject to tax, but a portion of that is in the 10% bracket and the rest in the 15% bracket. I am a low cost person as I really don't spend a lot, ever. I can continue to live within this amount.

BTW, I learned this the hard way, and had to send the feds a lot more money. That won't happen ever again!

PS I just had another side thought. Not really a Roth vs. traditional IRA, but when you cash in your traditional IRA, you pay regular income taxes on the income. If you had your money in a taxable account and sold a stock or fund, you could get the long term capital gains rate, which is a maximum of 20% (for you rich volk) or a 0 - 15% for us regular people.

Gives me yet another reason to wonder if the traditional IRA is really that good of a deal?