How a Roth IRA Can Help You Make the Most of Social Security

By Todd Campbell Markets Fool.com

If you're earning income by working, and also collecting Social Security, you might be missing out on a valuable strategy that can increase the likelihood of maintaining financial security in retirement. Are you making the most of your Social Security income? If you're not contributing to a Roth IRA, the answer may be no.

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A retirement savings windfall

Social Security supplements income for tens of millions of American retirees who continue to work part-time or full-time, and in these cases, contributing to a Roth IRA in retirement can pay off big.

Unlike traditional IRAs, Roth IRAs don't require minimum distributions at age 70 1/2, and that makes them the perfect destination for Social Security income.

Roth IRAs are funded with after-tax dollars, and the contribution limit for a Roth IRA is $5,500 in 2017. Workers over 50, however, can contribute an additional $1,000 catch-up contribution, so retirees can sock away up to $6,500 of earnings in a Roth IRA every year.

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Those annual contributions can translate into substantial savings.For example, a 66-year-old retiree who earns enough to contribute the maximum $6,500 per year into a Roth IRA could end up with an additional $151,294.74 at age 81, if earning 6% returns annually.

Importantly, because Roth IRAs don't require minimum distributions, retirees can use them as an important part of their estate-planning strategy.

If your spouse is the sole beneficiary on your Roth IRA, it can automatically be converted into their own Roth IRA upon your death. Your spouse can take distributions over his or her lifetime, or choose not to take distributions, so that the account can continue to grow. Your spouse can also contribute to that Roth IRA, so long as your spouse is earning income from work.

Further, your spouse can name another beneficiary to their Roth IRA, such as a child, and after your spouse's death, that beneficiary can take withdrawals over his or her lifetime, too. In this manner, a Roth IRA can conceivably provide your family with an important source of additional income even decades after your death.

Funding your Roth IRA with Social Security

While many Americans' dream of retirement doesn't include work, TransAmerica finds that roughly 28% of workers hope to continue working at least part-time in retirement, including 25% of baby boomers. Between those who hope to work in retirement, and those who will have to continue working for financial reasons, 51% of workers will work either part-time or full-time in retirement.

If you're among them, then claiming Social Security as early as you can, and using that supplemental income to fund your Roth IRA, could be a better decision than waiting to claim Social Security to receive larger payments.

As a refresher, Social Security is designed to pay out the same amount of money over your lifetime, regardless of when you claim. As a result, claiming earlier than your full retirement age, or the age at which you're entitled to 100% of your monthly benefit, results in a smaller check, while waiting to claim until after your full retirement age results in a larger check.

The earliest age you can claim Social Security is 62, and if you're turning 62 this year, then your full retirement age is 66 and 2 months. If you claim Social Security at 62, your Social Security check will be roughly 26% lower than it would be if you waited until full retirement age to claim. For instance, if your benefit at full retirement age is $1,000, then you'd receive $741 per month.

Since the average retired worker will collect $1,360 per month in Social Security income this year, there's a very good chance your Social Security payments will be large enough to contribute the maximum allowed in a Roth IRA.

A few important tips to consider, however, before embracing this Roth IRA strategy. First, you can only contribute up to the amount you earn from work to a Roth IRA, so if you earn only $2,500 from a part-time job, then that's the most you can contribute. Also, if you claim Social Security benefits early, and your earnings are above $16,920 in 2017, then Social Security will reduce your benefit check by $1 for every $2 you earn above that income limit. Finally, if your earnings eclipse specific income levels, you may have to pay income taxes on some of your Social Security. For these reasons, you'll want to do a little math before committing to this approach.

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