Weekend Reading: Avoiding the Social Security Tax Torpedo
This article appears as part of Casey Weade's Weekend Reading for Retirees series. Every Friday, Casey highlights four hand-picked articles on trending retirement topics and delivers them straight to your email inbox. Get on the list here.
Weekend Reading
While tax planning for the greatest long-term efficiency in retirement, be wary of increasing taxable income. Upon doing so, there are two major situations you could find yourself in, both of which are discussed by past Retire With Purpose podcast guest, Wade Pfau, here.
READ THE ARTICLESocial Security Tax Torpedo: The reality is, up to 85 percent of your Social Security benefits can be taxed, and the rules that determine that taxation can create what is known as the “tax torpedo”. As soon as you begin receiving benefits, the torpedo can occur with each $1 of additional income from qualified plan distributions. In brief, you are not only taxed on that additional income, but your Social Security as well.
As shown via the tables in this article, attempting to pinpoint your taxable Social Security benefits is complicated, which makes it difficult to connect your taxable income to marginal tax rates. Most notably, it will depend on your tax bracket, and vary based on your Social Security benefit amount. As a result, this unfortunately means there is not just one “tax torpedo”, but many that can form. Wealthy individuals may be unable to avoid the storm, but others, through proper tax bracket management or possibly delaying benefits, can utilize strategies to fend it off.
Increased Medicare Part B and Part D Premiums: Increasing taxable income can also cause issues when it comes to your Medicare expenses. Your Part B and D Medicare premiums are determined by your Modified Adjusted Gross Income (also known as MAGI, adjusted gross income plus tax-exempt interest), which can in turn create higher taxes on other sources of income. Not to mention, your MAGI for Medicare is taken from two years prior to receiving benefits, making tax planning in this realm of your retirement especially key.
Every dollar counts: You’re supposed to be in a lower tax bracket in retirement than when you were working. However, even if you are, you could still find that an additional dollar of income results in an effective tax rate of 40.7 percent, or could put you in the 12 percent Federal tax bracket.