While we offer no direct tax advice at Geyer Law, collaborating with our clients’ tax advisors in arriving at a coordinated plan, we’re always alert for threats and opportunities that affect estate planning

They’ve dubbed it the “tax torpedo”, referring to extra taxation of Social Security benefits. True, half of retirees don’t need to worry about the “torpedo”, simply because their income is too low. But for many of the retirees trying to preserve the wealth they’ve spent so many years of their lives building (and out of which they hope to provide a legacy to heirs), the additional – and in large part unexpected – tax burden comes as a very nasty surprise.

The taxation of Social Security benefits works as follows:

  1. Your “provisional income” is calculated, which amounts to your modified adjusted gross income added to half of the Social Security benefits you received during that tax year. So? Provisional income includes income from tax-free bonds, and required minimum distributions from 401(k) and IRA accounts.
  2. Once your provisional income is greater than $25,000 ($32,000 if you are half of a married couple filing jointly), 50% of your social security benefit becomes taxable. 
  3. This “new arithmetic” can truly have a torpedo-like effect, with the capacity to push you into a whole different tax bracket, as Ilana Polyak points out in a CNBC piece, possibly as high or even higher than when you were employed full time!.
  4. An important caution is that large Roth IRA conversions can also impact Medicare premium levels.

Financial planners recommend several strategies to avoid the worst of the torpedo’s effects, including converting traditional IRAs to Roth IRAs, funding additional spending needs with income sources generating little taxable income (cash reserves, Roths, or the sale of investments with small gains), as Roger A. Young, CFP® points out in Kiplinger..

“The tax torpedo is just one reason to plan thoroughly years ahead of RMDs,” notes Roger Young, CFP® in T.Roweprice.com. At Geyer Law, that’s exactly our reason for recommending early – and ongoing – estate plan review. Certainly the tax torpedo and the Medicare premium issue add complexity to the planning, and of course you want to reduce the chances of outliving your money. But in addition, careful planning can protect assets that will become your legacy for the next generation and for the worthy causes your support.

– by Ronnie of the Rebecca W. Geyer blog team