I think I torpedoed myself ...

[GaryInCO]

I never quite understood the "tax torpedo" thing. Didn't think it really applied to me. But of course it did.

I'm 67. Hit my FRA in January. I've been self-employed for decades, and I had planned to keep working part-time until 70ish, then start SS. But for different reasons my two main clients that accounted for basically all of my income for the last 5 years went poof, right before I hit FRA. Huh, I figured, must be time to retire. So I started SS and got my first deposit in March this year.

Now that I (think I) understand the tax torpedo situation, I think I should have drawn down the IRA before starting SS. I'm within my first year of benefits, so I think I can back out of it? For various reasons my IRA is much smaller than it "should" be, but together with other income (mostly rental properties) the IRA would carry me for a little while.

Looks like I need to submit a form SSA-521 to initiate the process. I think I'd have to pay back the SS I've already received, including Medicare premiums. That would eat about half my IRA. Then the other half would carry me through 2024, and my Roth would cover most of 2025. I'll turn 70 in September 2026. I'm not thrilled to do it, but I could draw down my taxable accounts to stay afloat until I hit 70. My taxable accounts are much healthier than my IRA, but not enough to get careless with them.

I get 8% increase in benefits for each year after FRA, 2/3% per month. So if my IRA/Roth carried me through 2025 and it took 9 months of taxable withdrawals to get to 70, that 9 months would add 6% to my benefits. Probably worth it, since the 6% increase would pay back the 9 months of withdrawals in about 13 months. I think. And in Sept 2026 I can apply for SS again, and my SS check will be about 30% higher than it is now.

Am I missing / misunderstanding anything? Anything else I should know?

 

[levindb]

I strongly suggest you pull together a 20-30 year plan. You have provided a review of a 2-3 year plan, and suggested something about a tax torpedo, but shared no details about taxes. Normally one would delay taking funds from a Roth so that you would have the most benefit from tax free growth. You also suggest that your IRA would only cover you for 2024, after you paid back your 2023 SSA benefit.

It appears as though you will be living on just your SSA benefits in 2026...and that is normally not a good thing. It is likely that you will not be paying much in taxes, depending on the rental income that you have,

I would try to focus on the long term first, and then look at the details of the short term (~3 years) to set yourself up for success.

 

[TheWizard]

I don't see any immediate tax torpedo problem.
If you decide to sell those rental income properties at some point, you would certainly have much higher taxes in each of those years.

I agree that you should put together a spreadsheet showing your retirement income plan for the next ten years to start with.
You also need to define your desired retirement income level...

 

[pb4uski]

I don't see any immediate tax torpedo problem.
If you decide to sell those rental income properties at some point, you would certainly have much higher taxes in each of those years.

I agree that you should put together a spreadsheet showing your retirement income plan for the next ten years to start with.
You also need to define your desired retirement income level...

+1 Look at various scenarios using https://www.irscalculators.com/tax-calculator

If you did reverse you SS then you could hopefully do low or no tax cost tIRA withdrawals and allow you SS benefit to grow 8% each year.

 

[Al18]

If you delay your SS to get a bigger benefit check when you are 70, you will absolutely pay more taxes.

Rule of thumb is to delay SS until FRA or possibly later, do some Roth IRA conversions in low tax years. For spending, sell some stock from your brokerage account before taking SS or IRA withdrawals. Leave your IRA and Roth IRA alone so it continues to grow.

You current plan achieves some of these goals, but spending your Roth IRA now seems to go against most advice.

I recommend running your income and tax numbers for 20 years to see how this all plays out before making any changes as you described.

 

[Rianne]

You didn't mention if you are married. When I plug numbers in:

https://www.irscalculators.com/tax-calculator

The tax bracket will go over 12% if DH passes and I file Single 65+. And there is a likelihood of taxes going up. Our tax bracket will stay in the 12% with RMDs if we file married/jointly/65+ because we plan to use the interest from the tIRA for income. DH has not taken SS yet. Plus, we're 40% equities in the trust part of our portfolio and plan to stay that way for growth.

 

[4legsgood]

My impression is most discussions here about tax torpedo are about RMD's for people with large amounts, > 1million, in a traditional IRA.

Selling real estate can cause a big tax hit too, but isn't legally mandatory like RMD's.

 

[Chuckanut]

My impression is most discussions here about tax torpedo are about RMD's for people with large amounts, > 1million, in a traditional IRA.

Selling real estate can cause a big tax hit too, but isn't legally mandatory like RMD's.

I am wondering how many people will end up in a higher tax bracket and maybe even get IRMAA'd due to all the interest we are earning on our bonds and CDs. I expect many middle class tax payers will be caught by surprise. Not this illustrious group, of course. We all know better.

 

[Exchme]

I agree with OP's general idea. For OP's situation, where they need to "not get careless", then maximizing SS is the right plan. Markets are very careless, so in this situation, you don't want to rely on them, you want to maximize the inflation adjusted, guaranteed-for-life income. Meaning waiting until 70 to claim SS.

That said, I would probably leave the Roth alone, I doubt there would be any taxes due on sales from taxable in the next few years anyway.

Also, a full model might show that leaving the IRA alone and just drawing down taxable is better than liquidating the IRA. The idea being that drawing down bonds in taxable in trade for future larger SS benefits reduces future tax drag from taxable by an amount about equal to what the situation would be with RMDs anyway.

 

[audreyh1]

I am wondering how many people will end up in a higher tax bracket and maybe even get IRMAA'd due to all the interest we are earning on our bonds and CDs. I expect many middle class tax payers will be caught by surprise. Not this illustrious group, of course. We all know better.

It’s definitely a factor this year, but because my capital gains are coming in much lower than expected, it’s mostly a wash except I finally am paying a sliver at 22%. I’m always above 12%, but the excess has been at capital gains rates until this year.

I’m will actually have to harvest some capital gains to stay in the first IRMAA level for 2025. Why would I do this? To reduce future years capital gains distributions from my legacy non-index funds. Chipping away at them when I can.

 

[pb4uski]

I am wondering how many people will end up in a higher tax bracket and maybe even get IRMAA'd due to all the interest we are earning on our bonds and CDs. I expect many middle class tax payers will be caught by surprise. Not this illustrious group, of course. We all know better.

I don't think this is a high risk because fewer middle class taxpayers seem to have very large taxable portfolios other than those who built and then later sold a business or possibly some super savers. If you have a large tIRA the extra interest will only impact when withdrawn.

 

[GaryInCO]

Well those weren't the answers I expected.

My understanding is that the "tax torpedo" refers to the sharp and often-unexpected increase in taxes on SS income. I believe each additional dollar of SS income effectively increases your marginal tax rate to 150% - 180% of your normal marginal rate, so you end up paying upwards of 40% marginal. So to avoid it, you want to totally drain IRA accounts *before* starting SS, so you don't have the IRA income boosting your SS taxation. No? So I'd want to un-start my SS to avoid the extra taxes. Then I also said "OK if I'm un-doing my SS election for a while, then maybe I can delay SS to age 70."

My IRA is small enough that maybe the tax saving isn't worth the headache, but delaying SS to 70 is.

If I do it, I realized I should bleed my IRA to delay re-starting SS (to avoid the torpedo), but probably NOT the Roth. There's no benefit to drawing down the Roth so I should let that grow tax-free. That means a bigger hit on my (dwindling) taxable accounts but the Roth will still be there.

To answer some of the questions:

Unfortunately I'm single. The plan only includes me, and my children who will inherit the estate.

I only discussed a 2-3 year plan because that's the duration of the torpedo issue. After that I have other income (taxable account, rental properties) that should support me OK. I've actually been living on that & SS all year, since I've had < $10k of w*rk income all year. And in 4.5 yrs I'll pay off my car loan, and my effective income will jump $1050/mo. I should only need to tap my taxable accounts for unusual expenditures. Like this week we're installing solar on my house. I pulled $32k out of the taxable accounts ($22k after tax credits), but it should save me about $2k/yr initially and more as time goes on & elec rates increase.

I've done a rough retirement plan using the calculator at https://www.newretirement.com/planner/. It suggests by the time I hit 90 in 23 years, my taxable accounts should grow 50%-100% and my total net worth more than double. And it's fairly conservative, assuming only 3.5% return on my accounts and my real estate. In reality my houses have gone up 6-7%. I'm fairly comfortable with the projection, since the incomes currently pay almost exactly 100% of my expenses without tapping into the taxable assets. Over time that will improve, since my major income sources (rentals and SS) are indexed to inflation and half of my expenses (mortgage, car loan) are fixed.

I shouldn't owe any fed income tax for a while, since I'll get about $10k in tax credits from my solar install. I don't really know yet what my tax hit will be, so I don't know how long that credit will last. I've always had a CPA do my taxes (business & personal) and I was planning to do it myself after the business income went away, but maybe I'll have her do one more year to give me an example. Even after I retire my tax situation will be a little messier than the typical "living on interest, dividends, & cap gains" retiree.

 

[audreyh1]

The tax torpedo generally refers to when you reach RMD age and the combination of RMDs and SS increases your tax bracket considerably. So 73+.

This can be avoided by drawing down IRAs via Roth conversions or use for spending before taking SS and before RMD age, but this is still tricky as MAGI can impact ACA eligibility and later IRMAA brackets.

If IRAs are a small part of investable assets this may not be a concern.

 

[Dtail]

A related RMD question which I have asked in a different thread but no response.
Now that they are changing the RMD schedule of first withdrawal from 70 y.o. to eventually 75 y.o., will the required distribution percentage be the same for year 80 for the person starting at 75 as for the person starting at age 70?

 

[audreyh1]

I did answer in the other thread.

Yes.

The table is based on age. It doesn’t matter which year you start. They all use the same table (well there might be a different one for much younger spouse or something).

 

[Dtail]

I did answer in the other thread.

Yes.

The table is based on age. It doesn’t matter which year you start. They all use the same table (well there might be a different one for much younger spouse or something).

Okay thanks.

 

[audreyh1]

Also RMD age moved up to 73 in 2023. It was 72 last year.

 

[TheWizard]

I agree that tax torpedo refers mainly to the SS+RMD income that wealthier retirees often have without mitigation.

The older thing involving SS being taxed at high marginal rates is GOING AWAY since it's not indexed to inflation.
Nowadays, a majority of us retirees have 85% of our SS benefit included in our AGI...

 

[Dtail]

Also RMD age moved up to 73 in 2023. It was 72 last year.

Yes I knew that. Just an example.

 

[dknighd]

Unfortunately I'm single. The plan only includes me, and my children who will inherit the estate.

I'm 90% sure our SS benefits will always be taxed at 85%. Unless they change the rules and start taxing more of them. Which I consider possible. You have to run your own numbers. You might find the same thing. I've passed the SS "tax torpedo". I just accept that 85% of our SS incomes will be taxed. You might also find that no matter what you do, your SS benefits will be taxed. But you have to run your own numbers to find out.



Really the main reason I'm putting of claiming SS is for survivor benefits. As a single person you do not have to be concerned about that. I would also put off claiming if I thought I might live longer than average, which is possible even though I smoke.


In your shoes I would not bother going through the paperwork to undo a decision you have already made. i.e. claiming SS. Unless I was darn sure there was a good reason for it.


I'm guessing, and this is just a guess, you will pay tax on 85% of your SS income no matter what you do.

 

[GaryInCO]

My understanding is that yes, RMDs can be involved in this tax torpedo thing. But I'm not hearing anybody explain it the way I've seen it described by financial planners. See e.g. the video below -- he walks through examples that show how a $1000 RMD (or other income) could be taxed at a 49.95% marginal rate.

If I understand the explanation correctly, you get taxed 15% higher than you "should" between about $15k and $60k. The real "danger zone" is fairly narrow, i.e. it's only a big problem if your taxable income is between about $55k and $60k. Above $60k you're already into the higher bracket so the RMD or other income doesn't trigger a higher rate.

This CFA shows a max marginal rate of "only" 40.7%, but I don't think he's stacking as many things as the video below.

But that doesn't sound like that y'all are saying. Does these financial planners' explanations agree with your understanding?

 

[ShokWaveRider]

I do not take RMDs yet, but this year I think we will be torpedoed by the ACA.

DW was on ACA for 2023. We claimed the full subsidy as we have done in previous years as I have managed to control our income.

This year I took my SS and our taxable stash has been earning ~5%+. So that has tripled our subsidy number ..... BOOM Torpedo.

So, at the least we will have to pay ACA back the subsidy and our SS will be 85% taxed. Oh Well. But I guess at the end of the day we still will have not spent more than we earned, and we have not drawn down on our stash, so we should not really complain. I don't have to like it though.

 

[target2019]

My understanding is that yes, RMDs can be involved in this tax torpedo thing. But I'm not hearing anybody explain it the way I've seen it described by financial planners. See e.g. the video below -- he walks through examples that show how a $1000 RMD (or other income) could be taxed at a 49.95% marginal rate.

If I understand the explanation correctly, you get taxed 15% higher than you "should" between about $15k and $60k. The real "danger zone" is fairly narrow, i.e. it's only a big problem if your taxable income is between about $55k and $60k. Above $60k you're already into the higher bracket so the RMD or other income doesn't trigger a higher rate.

This CFA shows a max marginal rate of "only" 40.7%, but I don't think he's stacking as many things as the video below.

But that doesn't sound like that y'all are saying. Does these financial planners' explanations agree with your understanding?

I can't say for sure what applies to your situation. But you are more concerned about a Social Security tax torpedo than what most of us think of - the RMD tax torpedo. And that is due to your small IRA not adding up to much.

I think you need at least a ten-year plan, that helps you find possible outcomes (taxes and income) over longer period(s). See what happens with 2025 tax changes, and so on.

You have the impact of rental income as well as possible sale of investment properties. All of that can be modeled, and you can change values to see what happens each year. But looking at one or a few years may not be best.

I generally do not watch videos like the one you linked. The more opinions you have does not necessarily lead to the best choice for you. I've had more benefit from posting specific facts here, and following the discussion to test my understanding of models and possible future results.

 

[GaryInCO]

In your shoes I would not bother going through the paperwork to undo a decision you have already made. i.e. claiming SS. Unless I was darn sure there was a good reason for it.

As I said, I have steady income (rentals, SS) and indeterminate investment income. If I average just 5% on investments it would be roughly a 35% addition to my steady income, which by itself covers my expenses. So I'm not desperate to boost my SS check, but it would be nice. Trying to build the estate for my sons.

Backing out my SS election until age 70 results in a 30% boost in SS, which works out to about a 12% raise in my total steady income. That seems worth some hassle? Dunno, I'm not sure yet how much hassle it is. If it's just filing a form and paying back the SS payments, that's not a big headache. Biggest concern is how much it will draw down my taxable account.

 

[4legsgood]

You may know about this tool, includes Social Security income and NIIT:

https://www.irscalculators.com/tax-calculator