Did you know that Roth IRA income is not used to calculate the amount of your social security income the federal government will tax.This is GREAT NEWS! If you are not a tax professional, then you may not know why this is important so I’ll give you just a quick overview. 

The amount of income you have will determine how much of your social security benefit is taxable. The federal government will tax anywhere from 0-85% of your social security benefits based upon a formula used for determining your provisional income. Income sources include, but are not limited to pension income, taxable interest income, traditional IRA distributions, half of your social security benefits and even tax free income from municipal bonds.

Here is a quick simplified example. Let’s say you and your wife are both 66 years old. You have no pension income, and your only guaranteed income source in retirement is your social security. Between the two of you that totals $3,500 per month. As a couple you also have two million dollars in your ROTH IRA earning a fixed rate of 3% per year.

In this example, you would have $42,000 per year of social security income. And let’s assume that you just draw the interest from your ROTH every year without touching your principal. So you would have an additional $60,000 per year of tax free roth income. Under this scenario you would have a cash flow of $102,000 per year, NONE of your social security benefits would be taxed, and you would pay ZERO dollars in federal income tax.

Now let’s assume that instead of having a ROTH IRA your two million dollars is in Traditional IRAs.  If everything else is exactly as described above, then 85% of your social security benefits would now be taxable, and after your standard deduction and personal exemptions, you would pay approximately $10,856 in federal income tax. So even though you still have $102,000 of income, you only get to keep $91,077.

The fact that Roth IRA income is not included in the taxation of your social security benefits is just one more great reason why you should consider converting some or all of your traditional IRAs to Roth IRAs.  The fact that marginal income tax rates are currently at all time historical lows and that tax rates are set to go up automatically at the end of this year should be a compelling reason to sit down with a team of experts to help you determine if a strategic IRA to ROTH IRA conversion is a good idea or not.