Unexpected Retirement Taxes and Avoiding the Tax Torpedo

Unexpected Retirement Taxes and Avoiding the Tax Torpedo

Wednesday, 26 June 2019 13:05

Committing to investing in your retirement can be challenging when you are young. However, when you finally reach retirement, you can finally start enjoying the money you have been diligently saving for so many years. Unfortunately, the government could also cash in on your savings as you begin to draw from your Social Security and tax-free retirement accounts. In fact, many people are caught off guard, finding they are in an entirely different tax bracket in retirement than they were while working.


As the oldest Boomers are approaching age 70.5, many may be surprised by the amount of taxes incurred on their social security benefits, because income from the Required Minimum Distribution (RMD) of their IRA, 401(k), 403(b), and other defined contribution plans pushed them into a higher tax bracket. If your provisional income crosses a certain threshold, up to 85% of your Social Security Benefit can be taxed. In this article, we will address RMD, the so-called Tax Torpedo, and what to do to make sure you are prepared to keep as much of your money as possible.

RMD and the Tax Torpedo

What is the tax torpedo? Retirees are often caught unawares by the way in which RMD may push them into a higher marginal tax rate and cause income from social security benefits to be taxed. The higher the balances in your designated retirement accounts, the higher your annual RMD. If you do not withdrawal from your designated retirement accounts before you reach 70.5 years of age, you are at even greater risk of being hit by the tax torpedo.

Will my social security income be taxed? That depends on your provisional income. If your provisional income above a certain threshold, up to 85% of your social security benefits can be subject to federal income tax. Provisional Income can be determined by adding together your adjusted gross income, non-exempt interest, and 50% of your social security benefits.

If you are filing jointly, 50% of your social security benefits are considered taxable if your provisional income is between $32,00 to $44,000, and 85% is taxable if your provisional income exceeds $44,000. If you are single, the threshold for 50% taxable benefits is $25,000 to $34,000, anything above making 85% subject to be taxed. This can really add up, especially if you were not expecting for your benefits to be taxed in additional to your marginal income tax rate.  

How to Avoid the Retirement Tax Torpedo

The tax torpedo is not inevitable for retirees. There are steps you can take now through retirement to avoid it.

  1. Financial Planning: Diversifying your retirement portfolio can help offset the income from RMDs. For example, Roth IRAs are not subject to the RMD requirement.
  2. Determine Early Whether The Torpedo Will Strike: Begin researching and determining early whether you are a likely candidate to be struck by the tax torpedo and plan accordingly.
  3. Begin Making Withdrawals: Once you reach age 59.5, you can begin making withdrawals from retirement accounts without incurring penalties. Managing these withdrawals can reduce the amount subject to RMDs and help you stay below the threshold for social security tax by the time you are 70.5.
  4. Delay Social Security Benefits: Though you can begin receiving full social security benefits once you reach retirement age, delaying them till you turn 70 can help mitigate your provisional income.
  5. Consult a Financial Advisor: The best thing you can do to is speak to your trusted financial advisor. Faw and Associates many years of experience helping people plan and invest for retirement and avoid being caught off guard by unexpected taxes or other expenses.
  6. Be Prepared: To some extent, having your social security benefits subject to being taxed may be unavoidable. Talk to your CPA and financial advisor to make sure you are fully prepared to surrender as little of your investment as possible.

The time is not to begin planning to steer clear of the tax torpedo. The younger you are, the more you can do to avoid it altogether. Here are Faw and Associates, we are committed to working with you in every area of financial planning, from retirement and college investments to business accounting and taxes. The tax torpedo does not have to sink your retirement ship. Contact us to begin making the most of your income, assets, and investments.