How RMDs Starting at 73 Can Make Up to 85% of Your Social Security Taxable

Required minimum distributions can create a tax problem many retirees do not expect, and the issue is not the withdrawals themselves. The bigger hit often lands on Social Security benefits.

Traditional retirement accounts such as IRAs and 401(k)s are attractive because contributions often come with an upfront tax break.

The drawback usually appears later, when account holders must begin taking required minimum distributions, or RMDs. For people born before 1960, RMDs start at age 73. Those mandatory withdrawals can create a recurring tax bill.

RMDs can also have a second effect. Depending on your overall finances, they may cause as much as 85% of your Social Security benefits to become taxable if the withdrawals are large enough.

Why income can determine whether Social Security is taxed

Some retirees pay no tax on their Social Security benefits. Whether benefits are taxable depends on your provisional income.

Provisional income is the total of your adjusted gross income, tax-exempt interest income such as municipal bond interest, and 50% of your yearly Social Security benefits.

If that amount is above $34,000 for a single filer, up to 85% of Social Security benefits may be taxable. For married couples filing jointly, the same applies once provisional income goes above $44,000.

Those thresholds may seem low, and that is because they were set many years ago without being adjusted for inflation.

RMDs matter because once they begin, they must be taken every year or a 25% penalty applies, even if you do not need the money from your traditional retirement account.

After the withdrawal is made, the amount is added to your provisional income. That can be enough to push your Social Security benefits into taxable territory.

Why account choice matters in retirement

If you want to avoid taxes on Social Security, it helps to know that not every retirement account has RMDs. Roth IRAs do not. Money held in a Roth IRA may keep your provisional income low enough to preserve the tax-free status of your Social Security benefits.

Another advantage of Roth IRAs is that withdrawals are generally tax-free, so they are not included in provisional income either.

For example, if you want to draw on savings to supplement Social Security and you use a Roth IRA, taking out $80,000 a year would not add that $80,000 to provisional income.

If retirement is approaching and most of your savings are in a traditional account, you may want to consider a Roth conversion before RMDs begin. That lets you move money into a Roth IRA.

Even if a full conversion is not possible, shifting part of your savings into a Roth IRA can reduce future RMDs. Smaller mandatory withdrawals may also help limit the chance that your Social Security benefits become taxable.