The Social Security Tax Torpedo, in One Page

For retirees with moderate incomes, there is a tax cliff that almost nobody mentions before retirement and almost everybody runs into during retirement. It is called the Social Security tax torpedo, and it can turn an extra $1,000 of IRA withdrawal into an effective $400 to $500 of tax liability — a marginal rate of 40 to 50 percent on income that nominally sits in the 12 or 22 percent federal bracket.

How Social Security gets taxed

Social Security benefits are not automatically taxable. Whether they are taxable, and how much, depends on a number the IRS calls "provisional income": your adjusted gross income plus any tax-exempt interest plus half of your Social Security benefit.

For a married couple filing jointly:

• If provisional income is below $32,000, none of the Social Security is taxable.
• Between $32,000 and $44,000, up to 50 percent of the benefit is taxable.
• Above $44,000, up to 85 percent of the benefit is taxable.

For a single filer, the thresholds are $25,000 and $34,000.

Where the torpedo lives

The torpedo is the zone where each additional dollar of regular income pulls additional Social Security into the taxable column. Imagine a retired couple with $40,000 in Social Security and $30,000 in IRA withdrawals — total income of $70,000.

If they take an extra $1,000 from the IRA, that $1,000 is itself taxable. But it also pushes them deeper into the 85 percent zone, which means an additional $850 of Social Security is now taxable too. So $1,000 of withdrawal creates $1,850 of taxable income. At a 22 percent federal rate, that is $407 of tax on a $1,000 withdrawal — an effective marginal rate of 40.7 percent.

Add state income tax in many states, and the effective marginal rate can cross 45 percent — significantly higher than the 22 percent the couple thinks they are in.

The two ways out

There are essentially two practical strategies for avoiding the torpedo.

The first is to do Roth conversions in the gap years between retirement and the start of Social Security benefits. During those years, your provisional income is low, and converting traditional IRA money to Roth at a 12 or 22 percent rate now is much cheaper than withdrawing it at an effective 40 percent rate later.

The second is to delay claiming Social Security to age 70. The larger monthly benefit at 70 means less of the household budget needs to come from IRA withdrawals, which keeps provisional income lower and avoids dragging the benefit fully into the 85 percent zone.

Why this is not just a high-income problem

The cruel feature of the torpedo is that it hits middle-income retirees hardest. Truly high-income retirees are above the 85 percent threshold no matter what they do, so the marginal rate on additional income is just the federal rate. Truly low-income retirees stay below the first threshold and pay no tax on Social Security at all. The torpedo lives in the middle, exactly where most retirees plan their withdrawals.

Our Social Security Tax Torpedo calculator shows you the marginal rate on the next $1,000 of withdrawal based on your specific income mix.