Social Security tax Torpedo

[USGrant1962]

...

Ex. we all knew it was coming, especially when we contributed to 401k's, IRA's, etc.

Nope. I never heard of an RMD until maybe 10 years ago when I started studying ER in earnest.

 

[RunningBum]

Whether it's a Hump or not depends on how you look at things.
Let's assume that 85% of SS income goes into your AGI for everybody, even low income folks who have no other income.
But then, we give a special Anti-poverty Tax Deduction to those folks on a sliding scale.
End result would be the same...

Not sure what your point is.

The fact is that I may have a situation where a small amount (less than $3K, probably) of RMDs may be taxed at a marginal rate of 49.95%, before settling down to a marginal 27% rate. I'm trying to avoid it by doing conversions now at a lower rate so I won't have to do RMDs later. Call it whatever you want but "the SS tax hump" seems like a more clear term than a "special Anti-poverty Tax Deduction".

 

[Car-Guy]

Nope. I never heard of an RMD until maybe 10 years ago when I started studying ER in earnest.

 

[Telly]

The phrase “Tax Torpedo” is inherently inflammatory, IMO. It sounds like something a partisan hack would invent to describe the political opposition and get people angry enough to send in more contributions to some politician, or dress in funny clothing and demonstrate outside the government buildings carrying home made signs they picked up at the printers.

The first time I heard of the "tax torpedo" was from a Scott Burns article quite a few years ago. Every once in a while he revisits it.

Scott is non-political, he seems to dislike politicians of any party equally!

 

[Montecfo]

The first time I heard of the "tax torpedo" was from a Scott Burns article quite a few years ago. Every once in a while he revisits it.

Scott is non-political, he seems to dislike politicians of any party equally!

I enjoyed his columns but it does seem needlessly dramatic to call it a torpedo.

 

[SevenUp]

The first time I heard of the "tax torpedo" was from a Scott Burns article quite a few years ago. Every once in a while he revisits it.

Scott is non-political, he seems to dislike politicians of any party equally!

Good point.

"A rose by any other name would smell as sweet."

A 49.95% marginal tax rate, on the other hand, has a somewhat different aroma, regardless of the label used....

 

[TheWizard]

Good point.

"A rose by any other name would smell as sweet."

A 49.95% marginal tax rate, on the other hand, has a somewhat different aroma, regardless of the label used....

That higher tax hump marginal rate is only for a small range of additional income as the low-income SS taxation discount phases out.

Some people would be happier if they just made 85% of your SS includable in your AGI no matter what your additional income is...

 

[TheWizard]

Good point.

"A rose by any other name would smell as sweet."

A 49.95% marginal tax rate, on the other hand, has a somewhat different aroma, regardless of the label used....

...and that 49.95% marginal tax rate seems incorrect nowadays, based on being in a 27% Federal tax bracket, which doesn't exist.

To the extent you are in the current 22% tax bracket, your tax hump marginal rate would be 1.85 * 22% = 40.7%.
But most of your tax hump is likely in the current 12% tax bracket, giving you a marginal rate of 1.85 * 12% = 22.2%...

 

[SevenUp]

Good point.

"A rose by any other name would smell as sweet."

A 49.95% marginal tax rate, on the other hand, has a somewhat different aroma, regardless of the label used....

...and that 49.95% marginal tax rate seems incorrect nowadays, based on being in a 27% Federal tax bracket, which doesn't exist.

To the extent you are in the current 22% tax bracket, your tax hump marginal rate would be 1.85 * 22% = 40.7%.
But most of your tax hump is likely in the current 12% tax bracket, giving you a marginal rate of 1.85 * 12% = 22.2%...

49.95% is correct. E.g., see the second example in the Married taxpayers section.

That 49.95% zone might not be more than ~$30K wide in most situations though.

 

[pb4uski]

That higher tax hump marginal rate is only for a small range of additional income as the low-income SS taxation discount phases out.



Some people would be happier if they just made 85% of your SS includable in your AGI no matter what your additional income is...

Or the SSA has a record of what you paid in to SS since it is on your SS statement and your earnings are used to calculate your benefit so it should be easy for them to determine the taxable portion just like is done for life annuities and report the taxable amount on your 1099-SSA. Would be fairer IMO.

 

[ShokWaveRider]

I am with the "So What" crowd. Why folks with high incomes resent paying a little tax never ceases to amaze me. Most do not even notice it, but complain nevertheless.

 

[TheWizard]

49.95% is correct. E.g., see the second example in the Married taxpayers section.

That 49.95% zone might not be more than ~$30K wide in most situations though.

Ok, if you merge Qualified Dividends into the mix then that's true.
But the two issues are independent; folks who have zero SS income are still subject to the QD hump as additional dollars of Ordinary Income cause more dollars of QD income to be taxed at 15%...

 

[RunningBum]

Some people would be happier if they just made 85% of your SS includable in your AGI no matter what your additional income is...

Where do you get that from? This is the very thing people who are in or short of the SS tax hump are trying to avoid. If it's not possible to avoid and the full 85% is taxable I'll accept it because what else are you going to do?

And yes, the tax hump really can be a 49.95% marginal tax. It's been spelled out many times how this can be.

 

[TheWizard]

Where do you get that from? This is the very thing people who are in or short of the SS tax hump are trying to avoid. If it's not possible to avoid and the full 85% is taxable I'll accept it because what else are you going to do?

And yes, the tax hump really can be a 49.95% marginal tax. It's been spelled out many times how this can be.

The SS tax hump is gradually shrinking as the start of the 22% tax bracket increases each year.

But the QD tax hump will always be with us under current law...

 

[Koolau]

The phrase “Tax Torpedo” is inherently inflammatory, IMO. It sounds like something a partisan hack would invent to describe the political opposition and get people angry enough to send in more contributions to some politician, or dress in funny clothing and demonstrate outside the government buildings carrying home made signs they picked up at the printers.

I like "threshold." Very neutral.

 

[Koolau]

IMO, there are lot's of "countermeasures" to avoid/minimize the impact of the so called tax torpedo. To me, it's more of long tax planning and speed bumps than a torpedo. YMMV

Ex. we all knew it was coming, especially when we contributed to 401k's, IRA's, etc.

Heh, heh, yeah, but we could never imagine how big our 401(k)s were gonna get! Great problem to have as you and others have pointed out.

Still... Who wants to pay more taxes?

 

[Koolau]

The first time I heard of the "tax torpedo" was from a Scott Burns article quite a few years ago. Every once in a while he revisits it.

Scott is non-political, he seems to dislike politicians of any party equally!

He wrote a book with Laurence J Kotlikoff "The Coming Generational Storm." IIRC that was where the authors went into a deep dive about the various issues surrounding SS (and maybe MC??.) There were (IIRC) examples of over 100% ultimate taxation (or reduction of income, at least.) Probably the "worst" example, again (IIRC) was regarding a second income in the family. The "hit" was astounding but I can't recall the details.

Very deep analysis on many subjects and I consider the book a good read for way more than humps or torpedoes. YMMV

 

[Chuckanut]

He wrote a book with Laurence J Kotlikoff "The Coming Generational Storm." IIRC that was where the authors went into a deep dive about the various issues surrounding SS (and maybe MC??.)

Kotlikoff was the fellow who introduced me to the Take SS at 70 and have more money to spend for life strategy. He’s good with numbers.

 

[Koolau]

Kotlikoff was the fellow who introduced me to the Take SS at 70 and have more money to spend for life strategy. He’s good with numbers.

Yeah, I've lost my copy of his book (with Bunrs) but the example was thorough and eye-opening.

 

[fishfactory]

62 for me.

Making Optimal Social Security Claiming Decisions - A Four Stage Analysis by Daniel Amerman

 

[qwerty3656]

62 for me.

Making Optimal Social Security Claiming Decisions - A Four Stage Analysis by Daniel Amerman

I'm not too worried about the other 3 points, but I've never seen the "medicare hold harmless" issue before. Is it right that if I don't take SS at 65 I could be paying more for medicare than someone else the same age as me who takes SS?

 

[fishfactory]

I believe the article is saying that you should have the Medicare payments taken out of the social security payment to avoid the potential scenario of paying higher rates.

 

[qwerty3656]

I believe the article is saying that you should have the Medicare payments taken out of the social security payment to avoid the potential scenario of paying higher rates.

So is it true you're not protected from 65~70 if you delay SS?

 

[audreyh1]

So is it true you're not protected from 65~70 if you delay SS?

I think hold harmless only applies if you are drawing SS and not subject to IRMAA. The point was to keep the SS check from shrinking due to higher Medicare payments, so by definition……

And I believe that once you start SS I’m pretty sure Medicare deductions from the check are required.

 

[Exchme]

The $230.80 is the total premium, not the surcharge. From the linked source, the base rate is $164.90 so the surcharge is $230.80 - $164.90 = $65.90.

On the other hand, you wouldn't want to use total income in the denominator because that's an effective rate and you'd want to use a marginal rate. The Worth pushing through the Social Security hump and/or IRMAA cliffs? wiki section has some good illustrations.

The marginal rate for going $1 over the first IRMAA tier is ridiculously large, as happens with any tax "cliff". At best (and coincidental to the quoted calculation), if one can completely fill the $52K-wide tier, the marginal rate due to IRMAA alone is $65.90 * 12 * 2 / $52K = 3%, as the second chart in the above wiki section also shows.

Don't forget about the Part D surcharge. Between the B and D, IRMAA is 3.6% of the difference between Tier 1 and the base, if you are perfect and are able to use all of that tier without going over. It gets a bit worse at the next tier, the incremental IRMAA surcharge is 4.73% between Tier 2 and Tier 1. Of course we all leave some margin so as not to spill into an unwanted extra surcharge, so we actually pay more than those rates on the income in that last tier.

It would be much simpler for planning if they just said add 4% or 5% on everything above the base tier until your Medicare cost is 85% of what they pay.