Suze Orman, a financial expert and best-selling author of several financial books, recently talked about the “tax torpedo” some retirees should prepare for on the Women & Money podcast. A tax torpedo line describes a tax surprise or an increase in the number of taxpayers who are expecting to pay.
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In his podcast episode, Orman offered tips on how to prepare for this tax event and how to protect yourself.
Keep reading to learn which accounts are most beneficial to those who want to reduce their taxes in retirement and help their nest egg last longer.
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Retired people can be hit by a tax torpedo if they cross certain tax loopholes. According to the Social Security Administration, single people can pay taxes on up to 50% of their benefits if their income is between $25,000 and $34,000. However, once individual filers exceed $34,000, their benefits are taxed at up to 85%.
For married couples, up to 50% of benefits are taxed on a combined income of $32 to $40,000, but if married couples exceed $44,000 in combined income, it is up to 85% of their tax.
Retirees can accidentally exceed this tax threshold if they do things like sell stocks or make large withdrawals from retirement accounts, such as a traditional IRA.
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Here are a few ways to avoid tax torpedoes.
Orman recommends in his podcast segment that his listeners invest in Roth IRAs, Roth 401(k)s, Roth 403(b)s, or Roth TSPs as a way to avoid unexpected taxes. Unlike traditional retirement accounts, investors add funds to Roth accounts with taxable income.
So, when people withdraw from a Roth account in bankruptcy, their money is tax-free. If you do not have a Roth IRA account, it is possible to convert a traditional IRA to a Roth IRA, called a Roth conversion or backdoor IRA.
There are some advantages to waiting to withdraw social security benefits until age 70, which is the maximum age. According to Fidelity Investments, the longer people wait to collect their Social Security benefits, the bigger their monthly check will be.
In fact, Fidelity explains that delaying Social Security benefits until age 70 can result in as much as a 24% higher benefit. This is also beneficial because it can give retirees more years without additional Social Security benefits, which can push their tax bill over a certain threshold.