Suze Orman, a financial expert and best-selling author of several personal finance books, recently spoke about the “tax torpedo” some retirees should prepare for on her Women & Money podcast. A tax torpedo is a phrase that describes a surprise tax or an increase in the amount of tax retirees are expecting to pay.
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In her podcast episode, Orman gave tips on how to prepare for this tax event and how to avoid it.
Keep reading to learn which accounts are the most advantageous for those who want to minimize their tax obligations in retirement and help their nest egg last longer.
When Can a Tax Torpedo Happen?
Retirees might get hit with a tax torpedo once they cross certain income thresholds. According to the Social Security Administration, single people may have to pay taxes on up to 50% of their benefits when their income is between $25,000 and $34,000. However, once individual filers exceed $34,000, their benefits are taxed up to 85%.
For married couples, up to 50% of benefits are taxable for a combined income of $32,000 to $44,000, but once married couples exceed $44,000 in combined income, up to 85% of their benefits are taxable.
Retirees can accidentally go past this tax threshold if they do things like sell an investment or make a larger withdrawal from retirement accounts, such as a traditional IRA.
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How To Avoid the Tax Torpedo
Here are a few ways to avoid the tax torpedo.
Invest in Roth Accounts
Orman recommends in her podcast episode that her listeners invest in Roth IRAs, Roth 401(k)s, Roth 403(b)s, or Roth TSPs as a way to avoid an unexpected tax bill. Unlike traditional retirement accounts, investors add money to Roth accounts with after-tax income.
So, when people withdraw from Roth accounts in retirement, their money is tax-free. If you don’t have a Roth IRA account, it’s possible to convert a traditional IRA to a Roth IRA, called a Roth conversion or a backdoor IRA.
Delay Your Social Security Benefits
There are some benefits to waiting to withdraw social security benefits until age 70, which is the maximum age. According to Fidelity Investments, the longer people wait to withdraw their Social Security benefits, the larger their monthly check will be.
In fact, Fidelity explains delaying Social Security benefits until age 70 could result in as much as a 24% higher benefit. This is also helpful because it can give retirees more years without an additional Social Security income, which might push their taxable income above a certain threshold.
Track Your Withdrawals
People in retirement need to plan their withdrawals carefully. Tracking retirement income regularly can help people stay on top of potential tax payments and prepare for tax season.
No one wants a surprise tax bill, and staying aware of withdrawals and regularly consulting with an accountant can help prepare people to manage their tax obligations.
Why This Matters
Many people worry they won’t have enough money saved for retirement. A recent AARP survey shows that among adults who actively save for their retirement years, only 36% believe they’ll have enough.
So, getting a tax bill that’s larger than expected on top of savings concerns can be challenging for retirees. That’s why it’s important to be aware of tax laws and how they will impact Social Security. After all, the more money people spend on taxes, the less disposable income they have in their golden years.
It is possible to avoid the so-called tax torpedo, but it requires people to carefully plan their withdrawals well before their retirement years. It involves timing their Social Security withdrawals, using Roth accounts strategically, and researching other possible options, like investing in a health savings account (HSA).
Again, if people need help deciding whether or not they’re prepared for retirement or whether or not they might be affected by a tax torpedo, contact a financial planner or an experienced accountant who can help.
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This article originally appeared on GOBankingRates.com: Suze Orman: 1 Trick To Avoid the ‘Social Security Tax Torpedo’ and Get More Money
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