rolling over DB to an IRA or taking it lump-sum to mitigate WEP/GPO & taxation

Submitted by Maria Ku on Tue, 2021-05-11 18:34

Hello,

I have been reading up on this recently and remain unclear. I wonder if I can ask you this question:

I have a DB (defined-benefit plan) from my employer. My goal is to minimize the impact of this DB on:
1. the amount of SS (social security) I would receive;
2. the amount of SS that would be taxable.

What would happen if I were to:
a. Rollover the entire balance of the DB into a Traditional IRA – would WEP (windfall elimination provision) to my own SS or GPO (government pension offset) to my spousal SS still apply – how? What if it were into a Roth IRA?
b. Get a lump-sum payout of the DB prior to applying to SS?

Or is there a better approach I have not considered?

Thank you for your help,

Maria Ku
Oakland, CA



Submitted by Alan - IRA critic on Tue, 2021-05-11 20:46

Per the link that follows, it appears that if the cash value of the DB is rolled over to any type of IRA, it will still be treated as a pension subject to WEP. In other words, doing a rollover will not increase your SS benefit or prevent it from being reduced due to WEP.
What Types of Pensions Trigger Social Security’s Windfall Elimination Provision (WEP)? — Oblivious Investor
Taxation of the SS benefit that you do receive will depend on the usual formula. Each year your AGI which is increased by IRA or pension distributions exceeds a modest amount determined by your filing status, more of your SS benefit becomes included in your AGI and taxable income. The maximum amount of your SS benefit that can become taxable is 85%. If you convert your IRA to a Roth IRA, it is likely that 85% of your SS benefit will be taxable in that year, but because a Roth does not have RMDs and will be tax free, a ROth distribution will not add to your AGI and you therefore might have less than the 85% max SS benefit included in your taxable income.

Submitted by Maria Ku on Tue, 2021-05-11 22:49

So if I were to roll over cash value of the DB into Roth IRA, then while falling victim to WEP just the same in all subsequent years, I will at least protect my SS from being taxed since all my other taxable income would be coming from a Roth, correct? Would it work exactly the same if it were GPO (spousal reduction), not WEP (reduction on your own SS record)? If I don’t have many years of substantial earnings, there is no way to escape WEP/GPO, right? All I can do is minimize the taxable amount of my (reduced) SS by turning all my retirment accts to Roth prior to claiming SS? Is this right?

Submitted by Alan - IRA critic on Wed, 2021-05-12 16:19

First, note that there have been on going discussions in Congress about eliminating or modifying the affect of WEP or GPO on SS benefits, so keep attuned to that situation. You are basically correct in your last post.
Otherwise, the decision to convert is basically the same, with or without WEP. You should convert if the marginal tax paid for the conversion is not more than the expected marginal rate in retirement if you don’t convert. You are paying taxes up front when converting, and conversions will reduce future RMDs which could result in more of the SS benefits you get being taxed. However, determination of the future taxes is complex because of where your AGI will fall. If it is very low, your SS benefits will not be taxable and if your future AGI will be high enough so that 85% of SS benefits will be taxable regardless of if you convert or not, it makes the determination easier. But if you fall in the AGI range where SS benefits are being added to taxable income with every dollar of other income, then the calculation is tricky. This range is not adjusted for inflation, so many people in the 80s or 90s that avoided income tax on SS benefits, later became subject to  such taxation because all their other income grew due to inflation. So you may not be able to escape having the SS income you do receive subject to tax, even if reduced your TIRA balance through conversion. You would have to crunch the numbers to determine where you fall in the AGI and taxable income scale.
Since any changes to reduce the WEP will just increase your SS benefits and taxable income, everything else being equal, you would convert more with increased SS benefits than if the WEP reduction remains in place.

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