Hidden Value is a new column in ThinkAdvisor where Joe Elsasser, CFP®, answers common questions with insights advisors and their clients may not have considered. This week he discusses avoiding the tax torpedo and how combinations of different retirement incomes can create ugly distortions in tax rates.
Most people know that Social Security income isn’t subject to taxation—at least, not directly. But depending on how Social Security funds are combined with other sources of income, it can push your total income above a certain threshold and trigger burdensome tax rates that eat up your benefits.
This so-called “tax torpedo” can strike if you aren’t careful about how you balance your Society Security benefits with other sources of income. In some cases, a client’s efforts to delay distributions from retirement accounts can actually put them at a tax disadvantage in the future. Retirees who use funds from their retirement accounts or even cash savings for living expenses often pay no federal income tax at all. They’re thrilled, but really, they may be setting themselves up for a big tax impact when their required minimum distributions begin.
In a column for ThinkAdvisor, Covisum President and Founder Joe Elsasser, CFP® discusses the threat of the tax torpedo and what advisors can do to ensure their clients avoid paying unnecessary taxes on their Social Security.
Here's an excerpt:
"Social Security income by itself is not taxable. It only becomes taxable when other income causes the total “provisional income” to exceed certain thresholds. It’s a multi-step process that can be calculated using the IRS worksheet. This structure creates what’s known as a “tax torpedo” or a “snowball effect.”