Many retirees feel like they are maneuvering through a maze of income traps. Many will find that a surprising amount of their Social Security income will make its way on the taxable income line of their 1040s, adding an unexpected and frustrating layer of complexity to tax season.
Who Does This Effect?
One group that is particularly susceptible to this scenario are retirees who opt to convert their traditional IRAs into Roth IRAs. While this move can offer long-term benefits, exceeding the funding limit can inadvertently push individuals into unexpected income thresholds, subjecting them to taxes on Social Security income that they assumed would be tax-free.
Retirees who have changes in marital status can be subject to Social Security tax implications. Whether due to marriage, divorce, or loss of a spouse, this shift in marital status can push you into higher income thresholds or tax brackets.
What is the Tax Torpedo?
Lower and middle income retirees can also fall into a tax trap called the tax torpedo. The tax torpedo is a phenomenon where a retirees income rises, whether due to part time work, withdrawals from retirement accounts, or other sources, they unknowingly put themselves into a cascade of tax consequences. As their income rises, a larger portion of their Social Security benefits also becomes taxable reducing the net amount they receive.
Options for Lowering Your Social Security Taxes
There are many different way that you can lower your taxes. We recommend meeting with a financial advisor who can help you with your retirement plan. Below are some generalized steps that you can consider:
- Seniors can take steps to avoid or minimize tax traps. These include delaying spending from one year to the next and judiciously tapping after-tax accounts to lower taxable income.
- Another option would be taking RMDs as a qualified charitable distribution if you don’t need the income. That way, it won’t trigger higher taxes or higher future Medicare premiums.
- Retirees in their 60s often pay little or no taxes before they begin taking Social Security. Many are living off after-tax savings, Roth IRA accounts, or inherited money. The standard advice is to spend this money before tapping tax-deferred accounts. Then, take advantage of their low tax bracket to convert money in tax-deferred accounts to Roth IRAs.
- Generally, annuities become taxable income when they’re taken as distributions depending on the account type. Virtually any investor who isn’t spending all the interest paid from a CD or other taxable instrument can benefit from moving at least a portion of his or her assets into a tax-deferred investment or account.
Conclusion
There are many rules concerning the taxation of income during retirement, and it’s crucial to know your situation to find ways to minimize the impact. As financial professionals, we can help you plan now to protect the retirement nest egg you have worked so hard to build. Call us today and let’s find some options that will work for you.
