Are Distributions from IRAs Earned Income?
For folks receiving full social security benefits, are distributions from traditional or Roth IRAS considered earned income for the purposes of computing taxable social security benefits on your 1040?
For folks receiving full social security benefits, are distributions from traditional or Roth IRAS considered earned income for the purposes of computing taxable social security benefits on your 1040?
Permalink Submitted by Alan Spross on Thu, 2012-04-19 19:03
Not earned income, but adjusted gross income in the case of TIRA distributions including RMDs. For Roth IRAs, the only AGI they contribute to is if earnings are distributed. Most retirees would either have qualified Roths or they would only be taking out contributions, so it is unlikely that Roth distributions would have any effect on taxes.
But until the maximum 85% of the SS benefits are included in AGI, any TIRA distributions including Roth conversions will usually drag SS into AGI. For example in the 15% bracket, a TIRA distribution of 10,000 will often drag 8,500 of SS income into AGI. Until 85% of SS has been included, this becomes a marginal rate of 1.85 X 15% or 27.75%. Once 85% of SS is included, the tax rate for additional amounts distributed actually drops even when the taxpayer goes into the 25% bracket since 25% is lower than 27.75%.
Even more complexity if taxpayer has qualiflied dividends and LT gains taxable at -0- in the 15% bracket. A TIRA distribution can push that income out of the 0 rate area into a 15% max rate, so while this is occurring the marginal rate is actually 15% for the TIRA income plus another 15% when the dividends are pushed out of the 0 rate to 15%. Total is 30%.
There might also be a certain amount that triggers both the SS addition AND the qualified dividend effect at the same time. This can create a rate over 50% for those amounts. Things are much simpler for those income willl include 85% of SS benefits no matter what else they do, or those whose qualified dividends and LT gains are already taxed at 15%. In those cases, you can just look at the marginal rate, eg 25% and that is basically what the distribution costs, perhaps a little more if itemized deductions are reduced or AMT is triggered.
All this is one reason that the cost of a conversion should be carefully considered before acting. It might cost far more than expected and that makes the long term benefit of some conversions questionable. Of course, RMDs are not discretionery and must be taken, but they have the same affect as conversions with respect to the effect on taxes.