Now we will use an example to illustrate.
You are retired now. Your retirement income comes from your IRA withdrawals and Social Security benefits.
If you are in the 25% tax bracket, you would pay 25 cents on an extra dollar withdrawn from your IRA account as ordinary income tax, and, now pay attention to this - you also have to pay another 21.25 cents on the Social Security dollar!
This means your effective marginal tax rate on that extra IRA dollar is 46.25%. If you add State tax, the marginal tax rate will be over 50%!
Now do you see the power of "Tax Torpedo"?!
Note the first Combined Income threshold is $32,000 for a married couple, and the second threshold is at $44,000, and they are not indexed for inflation; so over time, more and more retirees will be subject to the ‘Tax Torpedo’!
Next blog post we will discuss how to avoid the "Tax Torpedo".