Social Security Torpedo Tax with Pensions?

[MrLoco]

I know that there have been numerous threads on how to possibly avoid the SS torpedo tax ( having the maximum .....85% of SS benefits taxed.... while still years away from claiming SS benefits. Some have included:

1) Perform Roth conversions to minimize RMD's from a Trad IRA beginning at 70 and a half.

How is this supposed to provide any real benefit if it would be impossible ( not practical) to convert a meaningful amount every year before 70 and a half? Also this could mess with ACA subsidies.

2) Start withdrawing from a Trad. IRA between 59 and a half and 70 and a half to shrink the size of a Trad. IRA and delay claiming SS until age 70.

Again, might work between 65 - 70....but not before age 65 if an ACA subsidy is desired. Plus may very well vault the taxpayer into a higher bracket during these years.

3) You have a pension ....maybe both spouses have decent pensions, inherited Trad. IRA's (which require immediate RMD's). These income streams become "unavoidable" and will continue for life and result in 85% of SS income being taxable.

This is probably the biggest roadblock to trying to avoid the SS tax torpedo.


So do those of you in the above scenarios simply resign yourselves to the fact that most likely for life your SS benefits will be taxed at the 85% level? I admit it is a "nice problem to have " in that it means you have significant income streams in retirement but I am just asking if it is not worth trying to mitigate this "problem."

 

[audreyh1]

Damn the torpedos, full speed ahead!

Our SS benefits will be mostly eaten by taxes and Medicare payments. At least they should cover Medicare! We are well past the 85% income cutoff already, and it will probably only get worse.

 

[Dash man]

We'll, we'll never qualify for an ACA subsidy and plan to hold off on taking SS until we've rolled as much out of our traditional IRAs as possible, probably into the 25% bracket. When we do pay SS we'll have to pay tax on 85%. It is a nice problem to have, so we'll just grin and bear it as we pay our taxes. They'll still be lower than they used to be. We just hope to find decent health coverage when Cobra runs out from DW's work.

 

[jazz4cash]

I am taking IRA and 401k distributions above immediate needs within current tax bracket to reduce RMDs and diversify taxable vs tax deferred vs Roth. Plan to take SS at FRA. I've always budgeted for full taxation on 70% of SSA estimate.

 

[Another Reader]

Social Security in this household will always be 85 percent taxable. The good news (shhhh...) is California does not currently tax Social Security. Don't let Uncle Jerry get wind of that, though.

 

[Fedup]

Right now, according to Turbotax, my husband's SS is taxed at 85%. We did have some IRA withdrawal and we paid zero tax, or negative tax rate. I think there are other stuff to take into account also. I'm not given away my secret. I'm going to patent it.

 

[Alan]

We have actually come across another way to avoid 85% of SS being taxed by the IRS. We have moved to the UK and the UK/US tax treaty means that the IRS doesn't tax it at all.

The disadvantage is that the UK will tax 100% of it.

However, in the UK each person is taxed individually and DW only has some dividends as income at present so when she starts drawing her SS later this year it will be tax free as it is less than her UK personal tax free allowance.

 

[W2R]

Damn the torpedos, full speed ahead!

Our SS benefits will be mostly eaten by taxes and Medicare payments. At least they should cover Medicare! We are well past the 85% income cutoff already, and it will probably only get worse.

Love it! ("Damn the torpedos, full speed ahead!").

I am well past the 85% income cutoff already, too, and RMDs start next year. In my case there is some left over after taxes and Medicare. I've got to admit that it's sure great to get that deposit in my checking account each month!

Luckily I have retiree insurance so I don't have to worry about ACA stuff. I have a pension but it is fairly small.

 

[gerntz]

Our income & taxes will explode next year from RMD & SS. Oh well, we could be poor.

I assume some on here have calculated this, but in retrospect taking SS at 62 and withdrawing more from regular IRA might be the better after tax income maximizing option vs. waiting to take SS at 70. We'll never know.

 

[CardsFan]

Our income & taxes will explode next year from RMD & SS. Oh well, we could be poor.

I assume some on here have calculated this, but in retrospect taking SS at 62 and withdrawing more from regular IRA might be the better after tax income maximizing option vs. waiting to take SS at 70. We'll never know.

We have kind of taken the middle road. Taking IRA distributions now (61), will move some to Roth (probably all of DW's, since it will just make later distributions easier). SS at FRA for both (we are 6 months apart). I have always just assumed SS will be taxed on 100% (I know it is capped at 85% FOR NOW). Tax torpedo will hit at 70.5. RMD's will push us to the 25% bracket, I think.

First world problems.

 

[euro]

Our income & taxes will explode next year from RMD & SS. Oh well, we could be poor.

Exactly. Definitely a first-world problem (though I do sympathize with - and experience - the pain )

 

[stepford]

How is this supposed to provide any real benefit if it would be impossible ( not practical) to convert a meaningful amount every year before 70 and a half?

This is certainly an issue for me. More than half my investable assets are in Trad IRAs. If I convert to the top of the 15% bracket until 70.5 I'll reduce that from over 50% to maybe 40% of my assets. Yes, an improvement, but arguable how meaningful since RMDs will still put me firmly in the 25% bracket.

Better than nothing but the tax torpedo is still gonna hit me like the Lusitania.

 

[travelover]

..........So do those of you in the above scenarios simply resign yourselves to the fact that most likely for life your SS benefits will be taxed at the 85% level? ...........

Yes. Will still have plenty.

 

[Souschef]

Social Security in this household will always be 85 percent taxable. The good news (shhhh...) is California does not currently tax Social Security. Don't let Uncle Jerry get wind of that, though.

Same here! Because of RMD's SS will always be 85% taxable-not a bad problem to have
I looked into Roth conversions, but you can only convert $5K a year. If you have an IRA with 100K in it, it would take 20 years!

 

[Rustic23]

Tracelover +1

 

[samclem]

So do those of you in the above scenarios simply resign yourselves to the fact that most likely for life your SS benefits will be taxed at the 85% level?

To clarify: 85% of SS benefits might be taxed, but that's not the tax rate on them.
The "combined income" (AGI+nontaxable interest + 1/2 of SS benefits) reaches the cap of "85% SS benefits subject to taxation" at a fairly moderate level (for joint filers the level is reached at $44K).
The amount of SS subject to taxation is only a minor part of the total "tax torpedo" issue IMO, the biggest factor is all of these income streams forcing taxpayers into higher brackets. The tax damage is especially severe when one member of a MFJ couple dies and the survivor has to pay at the single rate (single standard deduction, single filer brackets).

All the steps you identified in the OP (plus others--taking 72T withdrawals from tIRA accounts at ages even earlier than 59, etc) can help to reduce taxable income (and/or provide more flexibility on when you take that income by reducing RMDs). For example, if a couple has $45K of "combined income" (see above), 85% of their SS will be taxed. But if they take the standard deduction ($16K) and two personal exemptions ($8100 total), then their taxable income is just $19,900. The first approx $18,550 of that is taxed at just 10%, and above that and through about $75,000 they'll pay at just the 15% rate (and pay zero taxes on long term cap gains and qualified dividends).

For most of us, reducing taxable income when in retirement and/or gaining flexibility on when to take it are the major reason to take the steps identified in the OP, rather than the goal of avoiding having 85% of SS taxed--because that's just going to happen and is unavoidable.

 

[omni550]

Don't overlook the possible impact on Medicare premiums

There's also another potential "surprise" that I haven't seen mentioned in this thread.

Medicare Part B & Part D premiums are based on MAGI income (as reported on your tax return 2 years ago) . Depending on when and whether you make tIRA withdrawals, Roth conversions, get a pension, and/or start SS could have an effect on premiums for a few years or possibly for your/your spouses's lifetimes.

Here's the chart for 2017.

omni

 

[audreyh1]

One reason I don't sweat it too much, is that only 14% of our current investable assets are in IRAs, so it's not a really large chunk like it probably is for a lot of people. Yes, RMDs will increase our income, and that income along with the social security income probably push some of it into the 25% tax bracket and wipe our out 0% cap gains income - at least when both of us are drawing RMDs.

But today we usually pay 26% AMT on our lowish ordinary income, and we would pay that rate on any Roth conversions we undertook, so it doesn't benefit us to do any conversions right now.

 

[ABQ2015]

Same here! Because of RMD's SS will always be 85% taxable-not a bad problem to have
I looked into Roth conversions, but you can only convert $5K a year. If you have an IRA with 100K in it, it would take 20 years!

I've never heard that the amount for Roth conversions is limited. Only the contributions are limited and there are income limitations and it must be earned income. Perhaps this $5K limit is a special case?

But I appreciate hearing from so many of you that you are also in this high tax situation and have decided to make the best of it. My pension alone puts me in the 25% tax bracket (single) and 85% SS taxable so the next goal is to avoid higher Medicare Part B premiums and/or the 28% tax bracket. Playing around with FIRECALC and i-ORP to determine whether to delay SS and dip more into my TSP or to do Roth conversions up to the 25% tax threshold has not been that beneficial - I see maybe an additional $1K a year of income. But those models do not account for Medicare Part B.

The RMD issue seems very dependent on rates of return. Unless I am doing the calcs wrong, it becomes a problem for me only if rates are 6% or greater. I have no need to leave an estate and want to spend it down. I plan to do more calcs before retirement and decision time in September. But I'm thinking that I'm just stressing myself and wasting time over something that I can't do anything about and just need to accept that I'm fortunate to have this problem.

 

[audreyh1]

There's also another potential "surprise" that I haven't seen mentioned in this thread.

Medicare Part B & Part D premiums are based on MAGI income (as reported on your tax return 2 years ago) . Depending on when and whether you make tIRA withdrawals, Roth conversions, get a pension, and/or start SS could have an effect on premiums for a few years or possibly for your/your spouses's lifetimes.

Here's the chart for 2017.

omni

So you are looking at Part B monthly premiums per person of:

$134 = $1,608 annually
$187.5 = $2,250
$267.9 = $3,214.8
$348.3 = $4,179.6
$428.6 = $5,143.2

So you have to double this for two people on Medicare.

and that doesn't include the Part D premium increases.

 

[marko]

I am just asking if it is not worth trying to mitigate this "problem."

Problem? I wish I could have only 85% of all the rest of my income similarly taxed. At least in MA (which seems to find ways to tax everything else) they don't tax my SS.

So I think I'm good with the current tax situation for SS.

The tax on 85% of my SS is about $2900. If I took an equal amount of my SS from my IRA instead, I'd pay (including my State income tax) $4600.

$1700 in my pocket each year! If I gotta pay taxes, I like this plan betta.

 

[braumeister]

1) Perform Roth conversions to minimize RMD's from a Trad IRA beginning at 70 and a half.

How is this supposed to provide any real benefit if it would be impossible ( not practical) to convert a meaningful amount every year before 70 and a half? Also this could mess with ACA subsidies.

Seems like there is the option to convert a massive amount in one year, suck it up and pay the massive tax hit, and then be done with it.

That's basically what I did a while back. There was a special one-time deal where you could convert in 2010 but pay the associated taxes over two years (2011 and 2012). Painful but I'm glad I did it.

 

[jollystomper]

3) You have a pension ....maybe both spouses have decent pensions, inherited Trad. IRA's (which require immediate RMD's). These income streams become "unavoidable" and will continue for life and result in 85% of SS income being taxable.

This is probably the biggest roadblock to trying to avoid the SS tax torpedo.


So do those of you in the above scenarios simply resign yourselves to the fact that most likely for life your SS benefits will be taxed at the 85% level? I admit it is a "nice problem to have " in that it means you have significant income streams in retirement but I am just asking if it is not worth trying to mitigate this "problem."

I can't think of a way to avoid the "problem". With a good pension, and if I delay SS for DW and I until our full retirement age (66), those alone will put our annual income at over $120K income, before counting interest, dividends, capital gains, and IRA/401K withdrawals (which we have to start taking before 70 1/2 to avoid having very large RMDs).

The only way I see eliminating the "problem" is a reduction or loss of my pension... so I'd rather have the "problem".

 

[almost there]

Have been thinking about this lately. Have about 500k in an IRA.
If I take 24000 per year and average a 2.75% return it would go for 30 years.
56-86. This would keep me around 70k annually till SS at 62. Then at 62 100k annually to 86.
With rental depreciation I should be able to stay in the 15% bracket going forward as it should go up in time. Not an easy thing to figure out................

 

[pb4uski]

Same here! Because of RMD's SS will always be 85% taxable-not a bad problem to have
I looked into Roth conversions, but you can only convert $5K a year. If you have an IRA with 100K in it, it would take 20 years!

I think you are confusing conversions and contributions. Contributions are limited to $5.5k a year in 2017 ($6.5k if you're over 50).

Conversions are not limited at all... do as much as you want as long as you pay the tax. I've converted almost $230k the last 4 years (and paid ~$17k in tax).