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recently with Investment Advisor from his base in Dallas. yourself set up so that once you start Social Security, even with
The prolific author has a new book due on Sept. 7. His a couple of million dollars of assets, you can avoid a big chunk
“Retirement Planning Guidebook” embraces all the impor- of the Tax Torpedo.
tant retirement decisions, including those concerning Social
Security, Medicare, tax efficiency — including, certainly, the Is Roth key to avoiding the Torpedo?
Tax Torpedo — and more. Yes. You’ll want to set up a Roth account. It doesn’t have to
be super-large at the start. But during the early period, you’ll
IA: What’s the Social Security Tax Torpedo? begin a strategy of aggressively converting to Roths. You can
Wade Pfau: It’s super-complicated and a kind of trap. convert from a traditional IRA or with a 401(k) rollover.
Once your taxable income — including Social Security, So during that early period, you’ll be drawing all your adjust-
IRA distributions, dividends, long-term gains from broker- ed gross income out of the tax-deferred account more aggres-
age accounts, part-time or full-time work [etc.] — that is, any sively at a higher tax bracket before you start Social Security.
measure of income that goes on your Form 1040, is above After you start receiving benefits, you’ll try to keep your
approximately $70,000, you can’t avoid the Tax Torpedo adjusted gross income lower, as from Roth distributions; pro-
[kicking in]: You’re going to be paying taxes on 85% of your ceeds from a reverse mortgage, life insurance, or the principal
Social Security benefits. from your brokerage account — taxable income sources.

What’s a concrete example? What’s a case that illustrates avoiding the Tax Torpedo?
Suppose you’re in the 22% tax bracket. If there’s a point where I have this one in my book: If a [hypothetical] couple starts to
one dollar of income causes 85 cents of a dollar of your Social claim Social Security and isn’t being very strategic about taxes,
Security benefits to become taxable, then suddenly you’re not they would run out of money at age 88. But by being more stra-
in the 22% tax rate any more — you’re paying more than 40% tegic around tax planning and avoiding the Tax Torpedo, they
as a tax rate. wouldn’t run out of money then — they’d get six more years of
And if that also pushes a dollar of your long-term capital retirement spending.
gains from the zero percent tax bracket to the 15% tax bracket,
now [that] tax rate [goes up too]. Would buying a QLAC — qualified longevity annuity
contract — help in staying relatively clear of the Torpedo?
You’ve said that in the future more people will be caught up in That certainly can be part of the planning. You’ll have this tax-
the Tax Torpedo. Why is that? able income source later in life, when by that point, you may
It’s happening now. I think about half of retirees have to pay have less taxable income. [A QLAC] can be timed to help with
taxes on their benefits. The main reason is that while most of the overall tax planning for your retirement.
the tax code is inflation-adjusted, the threshold for paying taxes It all depends on the structure of your assets. For example, if
on Social Security benefits hasn’t changed since about 1994. you have everything in a Roth, you can have a huge net worth
So every year, more and more people will be facing Social but no taxable income. So this isn’t just about net worth.
Security taxes just due to inflation.
When did the Tax Torpedo first rear its head?
Can’t the government change the code to address that? It began when the designers of the tax policy [came out with]
Yes. Most of the tax code is adjusted for inflation every year, the major tax reforms of 1983, when they started taxing Social
and tax brackets go up. They could easily decide to do that for Security benefits.
the Social Security tax threshold as well. I don’t know why This was during the Reagan years. Alan Greenspan was
they haven’t. head of the National Commission on Social Security Reform. It
was when Social Security was running out of money. The solu-
Is the Social Security Tax Torpedo something that advisors tion was the combination of lowering benefits and increasing
should be informing their clients about? retirement age, which increased taxes.
Yes. And an advisor trained in retirement planning — who has
the RICP [Retirement Income Certified Professional] designa- The government makes many significant decisions that
tion — definitely learns about this. affect taxpayers financially but about which they’re often
unaware. Agree?
So tax-avoidance strategies for the Tax Torpedo should be With Social Security, the Supreme Court ruled [in 1960]
addressed early in retirement planning, correct? that people have no property rights to their Social Security
It certainly requires planning. For instance, if you’re in your benefits. They’ve been paying into the System their whole
60s and retired but delay Social Security to age 70 and go on an [working] lifetime but they haven’t any rights to their benefits
aggressive Roth conversion strategy, you might be able to get [which therefore can be reduced or eliminated].

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