Will the ‘tax torpedo’ blow up your retirement?


About half of retirees don’t need to worry about the taxation of Social Security benefits because their income is too low, according to the Congressional Budget Office.

But those with more income could have a portion of their Social Security taxed as they pass certain thresholds. Social Security isn’t taxed when provisional income is less than $25,000 for individuals ($32,000 for married couples filing jointly). When income is between $25,000 to $34,000 ($32,000 and $44,000 for married filing jointly), 50 percent of Social Security income is taxable. When provisional income is above those amounts, 85 percent of Social Security is taxable.

Provisional income is calculated by taking your modified adjusted gross income and adding half of the Social Security benefits received.

“Another shocker is that it’s all your sources of income, even income from tax-free bonds,” said CFP Nancy Hecht of Certified Financial Group. The tax torpedo typically comes at age 70½ , when the required minimum distribution from tax-deferred 401(k) plans and individual retirement accounts kicks in.

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“I’ve had many of my clients pushed into a whole different tax bracket by having to take the RMD,” said Hecht. “Many of my clients will pay the same or more in retirement as they were paying while they were working.”

Consider the example of a single taxpayer whose taxable income puts her in the 25 percent tax bracket. She may think that withdrawing an additional $100 of income would increase her taxes by $25. But if she has hit the provisional income threshold, it could increase her income much more. In that case, an extra $100 would actually make $185 of income taxable because now she must include her Social Security, as well.

Now withdrawing $100 results in a $46.25 tax bill ($185 x 20 percent), resulting in a marginal tax rate 46.25 percent.

“It’s much more common for taxpayers at the lower- and middle-income tax brackets to get caught off guard by this,” said Morgan at Financial Service Group. “In many cases, higher-income taxpayers are already thinking about the impact of taxes on retirement.”

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