Is the “fiscal torpedo” coming for you? What do you want to know

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Dear Liz: I’m thinking about the best time to start drawing Social Security. I have no debt, I’m 61, retired, and blessed with retirement funds that should last until I’m 95 without social security. That said, when I start collecting Social Security, I understand that I am likely to be taxed at the full rate of 85% based on the monthly income I receive. Does it make sense to delay applying until age 67 or later knowing that I will be taxed more on the higher income, or should I withdraw earlier knowing that the tax payable would be less? Or, when I start receiving Social Security, will I reduce the amount of retirement funds I receive monthly?

Answer: The way Social Security benefits are taxed is somewhat convoluted and easy to misunderstand. Just to be clear: you would never lose 85% of your Social Security benefits to taxes. But if you have income outside of Social Security, up to 85% of your benefits may be taxable at your regular tax rates.

Taxes are based on what’s called your “combined income,” which is your adjusted gross income plus any non-taxable interest plus half of your Social Security benefits. If you are single and your combined income is between $25,000 and $34,000, up to 50% of your benefits may be taxable. If your combined income exceeds $34,000, you may have to pay up to 85% of your benefits.

If you’re married and filing jointly, a combined income between $32,000 and $44,000 could trigger taxes on up to 50% of your benefit. You may have to pay up to 85% of your benefits if your combined income is over $44,000, up to 85% of your benefits may be taxable.

Because of this unusual structure, people can face what is called a tax torpedo, i.e. a sharp rise and then a fall in their marginal tax rates. If your income is high enough, you will not be able to avoid the tax torpedo.

However, many middle-income people can mitigate its effects by postponing Social Security and tapping into their retirement funds instead. You can figure out how it works by searching for the phrase “fiscal torpedo”.

For a more in-depth analysis, search for William Reichenstein and William Meyer’s research paper titled “Understanding the Tax Torpedo and Its Implications for Various Retirees.”

Consider discussing your situation with a paid financial planner who can model different scenarios and give you personalized advice.

Wait to pull social security

Dear Liz: I’m about to turn 75. My wife is 67 years old. I started collecting social security when I was 70. My benefits are modest, but I also receive a monthly pension from the union. My wife is still working and plans to file for Social Security benefits at age 70, and she could receive three times my amount. Is there a provision that I could receive a higher amount now based on his income?

Answer: Your spouse should apply for her benefit before you qualify for a spousal benefit based on her work record. Once she applies, your spousal benefit will be 50% of her “primary insurance amount”, which is the benefit she would get at full retirement age. For a person born in 1955, the full retirement age is 66 years and 2 months.

If she applied now, your benefit could increase, but she wouldn’t get the deferred retirement credits that would increase her checks by 8% for each year she defers her application until age 70.

Generally, it’s a good idea for the person with the highest benefit to delay applying as long as possible, because it’s their check that determines what the survivor gets. But there are always exceptions, so it would be a good idea to research your options. Social Security Solutions and Maximize My Social Security can help you model different claim strategies, or you can discuss your situation with a financial planner.

Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions can be sent to him at 3940 Laurel Canyon, #238, Studio City, CA 91604, or by using the “Contact” form on asklizweston.com.

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