February 25, 2018
Every week, Simply Money’s Nathan Bachrach, Ed Finke and Amy Wagner are answering your financial questions in The Cincinnati Enquirer. If you, a friend, or someone in your family has a money issue or problem, please feel free to send those questions to email@example.com
David in Lawrenceburg: My dad just started getting his monthly Social Security check (about $1200), but he also has a pension and some other investments. Will he have to pay taxes on that Social Security benefit?
Answer: Determining if your father's Social Security benefit is taxed is based on his “combined income.” This is the total of his adjusted gross income, non-taxable interest, and 50 percent of his Social Security benefit.
If he’s single and his combined income is between $25,000 and $34,000, he can be taxed on up to 50 percent of his Social Security benefit. If his combined income is more than $34,000, he could be taxed on up to 85 percent of his benefit. This, of course, also depends on what state your father resides in. (If he’s married filing a joint return, the combined income range is $32,000 to $44,000). No one pays federal income tax on more than 85 percent of their Social Security benefit.
If your father discovers he’ll be taxed on his benefit, there are some steps he can possibly take to reduce his tax burden. Depending on what other investments he has, he can consider converting his traditional IRA accounts to Roth IRA accounts. He will have to pay taxes on the conversion, but once the conversation is completed he will not have to pay taxes on his withdrawals and the withdrawals do not count towards his combined income. He needs to make sure he would have enough funds to pay for the tax implication of the conversion before moving forward. (He also has the option to do a partial conversion. This means that he doesn’t have to convert the entire account.)
This move could, however, trigger a higher tax bracket during the year he makes the conversion. Simply Money Advisors recommends working with a trusted financial planner (preferably a Certified Financial Planner™) and a tax professional to help your father make the best financial decision possible.
Once he turns 70 ½, he could also give his RMD (Required Minimum Distribution) to charity since this gift wouldn’t be included in his adjusted gross income.
The Simply Money Point is that your father could potentially be taxed on his Social Security benefits. It’s important to partner with a financial planner and tax professional to help him limit his tax obligation and make his money go further.
Mark from Mt. Airy: I know 529 plans are good for saving for college costs, but could it also make sense to use a Roth IRA instead?
Answer: There are a lot of benefits for both plans. 529 college savings plans allow individuals to contribute $15,000 per year ($30,000 for married couples), and withdrawals for qualified educational expenses are tax-free. Lifetime 529 contributions may vary from about $200,000 to $400,000, depending on the state you reside in. There may also be tax credits for investing in your state's 529 plan.
With a Roth IRA, you contribute after-tax money in order to get tax-free growth. You can only contribute $5,500 annually and another $1,000 a year as a catch-up contribution if you’re older than 50. But there are also income limits. If you’re a single filer you must make less than $120,000 to contribute the full amount, and $189,000 for married filers.
There can be a lot of flexibility with a Roth IRA. All Roth IRA contributions are eligible to be withdrawn at any time for any reason, tax-free. Educational withdrawals are not subject to a 10% penalty if you’re younger than 59 ½ (though you will have to pay taxes on any withdrawals above what was contributed). If you’re older than 59 ½ and you’ve held the account for longer than five years, you can make a withdrawal for any reason at any time and there are no penalties or tax implications. Plus, compared to 529 plans (which are run by states), there are usually more investment options when you open a Roth IRA.
Lastly, 529 plans must be claimed when filing the FASFA (Free Application for Federal Student Aid) form for student aid. This can become confusing when you have grandparents and parents who may contribute toward your child's college tuition. Roth IRA accounts are not claimed as an asset on the FASFA form.
The Simply Money Point is that both accounts have benefits that can be helpful when paying for a child’s education; but which one you choose depends on your particular situation.
Responses are for informational purposes only and individuals should consider whether any general recommendation in these responses are suitable for their particular circumstances based on investment objectives, financial situation and needs. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing, including a tax advisor and/or attorney. Nathan Bachrach and Ed Finke and their team offer financial planning services through Simply Money Advisors, a SEC Registered Investment Advisor. Call (513) 469-7500 or email firstname.lastname@example.org.