What is the Social Security Tax Torpedo?
At some point, you’ll be claiming your Social Security benefits which is taxable as ordinary income. This additional taxable income could cause your marginal tax rate to go up. The marginal tax rate is the additional tax paid on the next dollar of income. That seems pretty intuitive—you earn more income, you pay more tax. However the reason for the ominous moniker of a “tax torpedo” or “tax bomb” is due to how an extra dollar of income might increase the taxation of your Social Security benefits by having a marginal tax rate much higher than your regular marginal tax rate, even for those with relatively low income.
First thing to know, your Social Security benefits aren’t 100% taxable. These are based on income brackets where the benefits could be 50% taxable or if you have higher income, benefits are 85% taxable. That’s quite a difference in tax if your income happens to go over the threshold by even one dollar!
According to the Social Security Administration 2024 brackets listed below, if you:
File a federal tax return as an “individual” and your combined income is
- Between $25,000 and $34,000, you may have to pay income tax on up to 50% of your benefits.
- More than $34,000, up to 85% of your benefits may be taxable.
File a joint return, and you and your spouse have a combined income that is
- Between $32,000 and $44,000, you may have to pay income tax on up to 50% of your benefits.
- More than $44,000, up to 85% of your benefits may be taxable.
What is combined income, also called provisional income? It is a special formula Social Security uses to determine at which tax rate your benefits will be taxed. The calculation is:
- MAGI, modified adjusted gross income (this is AGI that does not include the taxable portion of Social Security benefits)
- plus nontaxable interest income
- plus 50% of your Social Security benefits for the year
Sum these amounts and see which tax rate for Social Security benefits applies to you. You may want to get your CPA involved to help with the calculations.
If your income sources already push you well into the 85% Social Security taxation rate, you’re already in a higher marginal tax bracket and not concerned about the tax torpedo. For others, there are strategies to reduce the taxable portion of Social Security benefits such as Roth IRA Conversions, delaying Social Security or drawing down more of your tax deferred accounts before filing for Social Security. Reach out to us at MainStreet to discuss how these strategies work.
For other articles on Social Security, see the following:
5 FACTS YOU SHOULD KNOW ABOUT SOCIAL SECURITY RETIREMENT BENEFITS Originally posted by Katherine Edwards on Jun 29, 2023
SHOULD I TAKE SOCIAL SECURITY WHILE STILL WORKING?
Originally posted by Cynthia Flannigan on Apr 8, 2021
