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Author: rustedSoul Three stars, 500 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 120807  
Subject: Roth IRA + Social Security Date: 12/17/1998 7:48 PM
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I've read all the Roth FAQ's and have not been able to come up with the answer to my question. All the current information about Roth's concerns contributions, conversions, and eligibility. What are the specific tax rules for withdrawals?

It at first seems like a question with a simple answer, because there are never any taxes to be paid if the withdrawals are within the guidelines for tax free withdrawals. Does this mean that the withdrawals will be totally absent from any income considerations on your tax return?

The reason this is important is that the government loves to play class warfare politics with your income.
(This is the most hideous and lothsome part about the tax code: little nooks and crannies designed to redistribute wealth). If your Roth withdrawals were considered income, for example, they could reduce your social security. So even though you pay no tax, they still consider it income for determining your social security tax rate. (That's right folks, if you have a large pension your ss benefits will be taxed at a higher rate). Currently, Social Security does not reduce your benefit level based upon IRA/pension income (only the tax side is affected by your level of pension income).

If Roth withdrawals are NOT considered income, then a Roth would give another potential tax advantage over a deductible IRA (all other considerations being equal). See, the deductible IRA is considered income and must be declared as such when a withdrawal is taken. Income is bad if you want to receive SS benefits.

This is the way I interpret the current tax code (look at page 25 of the 1040 instructions): social security benefits are taxed based upon only income which is taxable. Since Roth benefits are not taxable, a high income retiree would pay less SS tax than if income was distributed from a deductible IRA.

Do the tax expert gods agree?

rustedSoul

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Author: TMFTaxes Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: 7355 of 120807
Subject: Re: Roth IRA + Social Security Date: 12/19/1998 12:51 PM
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[[ I've read all the Roth FAQ's and have not been able to come up with the answer
to my question. All the current information about Roth's concerns contributions,
conversions, and eligibility. What are the specific tax rules for withdrawals?]]

Gee...those rules were discussed in a lot of details in my Roth IRA Part III which was the previewed tax post in the Taxes FAQ area. I'm sorry that you missed it. This weeks post deals with the penalty issues. You might want to check it out also. But I believe that most of your questions are answered in the Taxes FAQ series on the Roth IRA. But let's take a closer look and see what we have here.

[[ It at first seems like a question with a simple answer, because there are never
any taxes to be paid if the withdrawals are within the guidelines for tax free
withdrawals. Does this mean that the withdrawals will be totally absent from any
income considerations on your tax return?]]

I don't know what the word "considerations" mean with respect to this issue. Perhpas you'll define it for me as we move along.

[[ If your Roth withdrawals were
considered income, for example, they could reduce your social security.]]

Not so. Only EARNED income reduces your actual SS benefits. Other unearned income (such as rents, royalties, dividends, interest, gains, and pensions) have no impact on your receipt of SS benefits...regardless of your age. Now, your SS may be subject to TAX given the size of your total income. But your SS benefits will not be reduced by virtue of your "pension" income.

[[ So even
though you pay no tax, they still consider it income for determining your social
security tax rate. (That's right folks, if you have a large pension your ss benefits
will be taxed at a higher rate).]]

Agreed. But this is quite different from reducing your benefits.

[[ Currently, Social Security does not reduce your
benefit level based upon IRA/pension income (only the tax side is affected by
your level of pension income).]]

Agreed. SS also doesn't reduce your benefit level based upon other "non-earned" income such as interest, dividends, gains, pensions, etc.

[[ If Roth withdrawals are NOT considered income, then a Roth would give
another potential tax advantage over a deductible IRA (all other considerations
being equal). See, the deductible IRA is considered income and must be
declared as such when a withdrawal is taken. Income is bad if you want to
receive SS benefits.]]

Again, the receipt of taxable IRA income, regardless of Roth (via a non-qualified taxable distribution) or regular may impact the taxability of your SS benefits, but will not actually reduce your benefits. These are two entirely different issues.

[[ This is the way I interpret the current tax code (look at page 25 of the 1040
instructions): social security benefits are taxed based upon only income which is
taxable. Since Roth benefits are not taxable, a high income retiree would pay
less SS tax than if income was distributed from a deductible IRA.]]

But remember that certain tax free bond interest IS taken into consideration when computing modified AGI for taxable SS issues. So you can't simply look at "taxable" income and determine your tax on your SS benefits.

So, what you are really interested in is the definition of "modified AGI" with respect to the taxability of SS benefits. Here is how the code defines "modified AGI" for this purpose:

'Modified adjusted gross income' means adjusted gross income:

1. determined without regard to:

A. Any SS benefits that may be included in income based upon these rules;

B. the Code Sec. 135 exclusion for savings-bond proceeds used to pay expenses of higher education;

C. the Code Sec. 137 exclusion for amounts provided under employer adoption assistance programs;

D. the Code Sec. 911 exclusion from gross income for U.S. citizens or residents living abroad;

E. the Code Sec. 931 exclusion for income from Guam, American Samoa, and the Northern Mariana Islands; and

F. the Code Sec. 933 exclusion of income from Puerto Rico;

G. the Code Sec. 221 deduction for interest on a qualified education loan and;

2. increased by tax-exempt interest accrued or received by the taxpayer during the tax year.

Clearly, in my opinion, the tax free treatment of a Roth IRA distribution would not be included in AGI as the law is originally written, nor would it be a modification as the law is currently written. So, at least in my opinion, qualified Roth distributions would NOT have an impact on either SS benefits or the potential tax on those benefits.

Will this be so in the future? I don't know. Some tax pros believe that qualified Roth distributions will be "means tested" by some method in the future. Could that mean that some time in the future a qualified (i.e., tax free) Roth IRA distribution will be required to be added to "modified AGI" in order to determine the taxability of SS benefits? You guess is as good as mine.

But I certainly believe that as the law is currently written, a qualified Roth IRA distribution will impact neither SS benefits or SS taxablity issues.

[[ Do the tax expert gods agree?]]

I don't know about that. But my position is above.

Hope this helps..
TMF Taxes
Roy

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