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What is the Tax Torpedo — and How Can You Avoid It?


Understanding all the details and nuances of Social Security benefits can sometimes be difficult. For example, one source of confusion for many people has to do with whether or not Social Security benefits are taxable.

Social Security benefits themselves generally aren’t taxable, but there is a situation where a portion of benefits may become taxable. This is sometimes referred to as the Social Security “tax torpedo.”

Planning for the Torpedo’s Impact

The potential impact of the tax torpedo should be analyzed when planning Social Security distribution strategies. The tax torpedo occurs when a portion of Social Security benefits becomes taxable due to other sources of income in retirement lifting provisional (or total) income above the following annual thresholds:

  • If provisional income is less than $25,000 (for singles) or $32,000 (for married couples filing jointly), Social Security benefits are non-taxable.
  • If provisional income is between $25,000 and $34,000 (for singles) or $32,000 and $44,000 (for married couples filing jointly), 50 percent of Social Security benefits is taxable.
  • If provisional income exceeds $34,000 (for singles) or $44,000 (for married couples filing jointly), 85 percent of Social Security benefits is taxable.

Provisional income is calculated by adding half of Social Security benefits to modified adjusted gross income (MAGI). Note that MAGI includes all of the income earned in retirement, including income derived from tax-free bonds.

The Tax Torpedo and RMDs

The tax torpedo most commonly hits retirees when they turn 70½ years old and must start taking required minimum distributions (RMDs) from their IRAs and 401(k)s. These are required withdrawals from qualified accounts that must begin by April 1 of the year after a retiree turns 70½ to avoid a 50 percent tax penalty.

For example, consider Mary, a 71-year-old who’s in the 25 percent tax bracket. She wants to withdraw an extra $100 a month from her IRA and assumes that she’ll pay an extra $25 a month in income taxes.

However, the extra withdrawal pushes her past the $34,000 provisional income threshold, which means that 85 percent of her Social Security benefits are now taxable. So instead of paying tax on an extra $100 a month, she’ll have to pay tax on an extra $185 a month.

This pushes her tax on the extra $100 from $25 to $46.25. And it nearly doubles her marginal tax rate from 25 percent to 46.25 percent.

Dodging the Tax Torpedo

Avoiding the tax torpedo requires advanced planning long before you turn 70½ years old. If you wait until then, there’s very little you can do to lessen the tax bite.

One way to dodge the tax torpedo is to begin making withdrawals from your tax-deferred accounts (like IRAs and 401(k)s) during the early years of retirement. This is the opposite of traditional retirement account distribution strategies, which entail waiting until later to withdraw money from tax-deferred accounts to allow more time for growth.

But the traditional strategy can result in realizing too much taxable income after age 70½, which can push retirees past the provisional income thresholds. Waiting until later to withdraw money from tax-deferred accounts will result in smaller account balances and thus smaller RMDs after age 70½.

Early Planning is Critical

Utilizing this strategy requires a combination of taxable, tax-free and tax-deferred accounts that can be drawn from for retirement income. It may take many years to accumulate sufficient retirement funds in these accounts, which is why early planning to dodge the tax torpedo is so important.

Please contact us if you have more questions about the tax torpedo or would like to discuss strategies for minimizing its impact in more detail.

The commentary is limited to the dissemination of general information pertaining to Frontier Wealth Management, LLC’s (“Frontier”) investment advisory services. This information should not be used or construed as an offer to sell, a solicitation of an offer to buy or a recommendation for any security, market sector or investment strategy. There is no guarantee that the information supplied is accurate or complete. Frontier is not responsible for any errors or omissions, and provides no warranties with regards to the results obtained from the use of the information. Nothing in this document is intended to provide any legal, accounting or tax advice and Frontier does not provide such advice. This information is subject to change without notice and should not be construed as a recommendation or investment advice. You should consult an attorney, accountant or tax professional regarding your specific legal or tax situation.