It is a common misconception that IRA distributions are counted as normal earned income, which could potentially hurt your Social Security Income. if you are taking it before the age of 66, that is simply not true. It is considered investment income.
At Tru North Advisors, we aim to educate on the common misconceptions that even other trained professionals sometimes misunderstand and under educate on. When in doubt, you can always fact check with the Social Security Administration office to clarify.
Fact: The Social Security Administration does not count IRA distributions as income when determining your annual benefits, but the IRS does count them when determining your tax liability—Roth IRA distributions are the exception for both agencies. Before you start converting your IRA distributions to Roth IRA distributions, be aware that you will likely pay taxes on the converted amount and your social security benefits as a result.
How the Social Security Administration Defines Income:
The Social Security Administration reduces your benefits if you exceed the defined earnings limit, which is $18,240 for 2020. This number can change each year. Job wages, self-employment profits, bonuses, vacation pay, sick pay, commissions, or any other type of compensation reported on your W-2 will be factors when the SSA determines your income. Basically, pensions, annuities, interest, dividends, and IRA distributions are not counted.
How the IRS Defines Income:
The IRS uses a combined income approach to decide how your social security benefits should be taxed. Follow these simple steps to determine your combined income:
- Write down your adjusted gross income (This figure should include IRA conversions and withdrawals from your work’s retirement plan or 401K and IRA distributions from your IRA account.)
- Add your non-taxable interest and dividends as well as half of your annual Social Security Benefits from that year.
If the result is higher than $25,000 and $34,000, you could be taxed on up to half of your Social Security benefits. If the result is higher than $34,000, your tax liability will be on 85% of your benefits. Joint filers have different thresholds, $32,000 and $44,000. The numerical limits can change annually so make sure you have the most updated numbers.
The Bottom Line: You will not need to pay Medicare or Social Security taxes on IRA distributions, regardless of how your IRA was funded. Whether from after-tax contributions to Roth IRA distributions or pre-tax contributions to a traditional IRA or in an IRA from your workplace’s retirement plan, your Social Security taxes have already been paid. If you are unsure about any aspect of your IRA, reach out to Tru North Advisors. We want to clear up any misunderstandings you may have and help you maximize your assets.