How to Avoid Tax Torpedo
To avoid tax torpedo, you need to adjust the mix of income types to lower this ‘Combined Income’ number. There are 3 options you can consider:
a. Delay taking Social Security
By delaying taking Social Security (as late as age 70), you can increase your social security benefit, plus you will also have less taxable withdrawals to supplement your income. Note that if social security benefit is the sole source of income for a married couple with the standard income tax deductions, it is tax free.
b. Structure IRA withdrawals
You can structure an IRA withdrawal strategy to provide income during the period that starts from your retirement day 1 to the delayed Social Security benefit date of the primary worker. By taking withdrawals from the IRA before age 70, you reduce the mandatory distributions after age 70 1/2, potentially keeping more Social Security benefits tax-free.
c. Use Roth IRA
Finally, you should use money in a non-taxable Roth IRA, or in an after-tax savings or brokerage account, to reduce the need to withdraw taxable IRA money, because such withdrawals are non-taxable.
The Bottom Line
You need to think ahead about the assets you will be spending down in retirement, so you can manage your taxable income and avoid the ‘Tax Torpedo’.