If you are a way from the age where you will apply for Social Security or Medicare, there are ways you can avoid, or at least minimize, the stealth taxes. Image: RomanR/Shutterstock.com
By: John GrobeWhat are “stealth taxes”? When should I worry about them? How can I avoid them?
Stealth taxes are additional costs and/or taxes that are paid by those with earnings above a certain level, and that are not specifically identified as “taxes”. They might be called “adjustments” or “surcharges”. This article will look at three common stealth taxes, two of which strike retirees.
The first stealth tax we will look at relates to itemized deductions on one’s federal income tax return. This will hit anyone with income above a certain level, regardless of their age. Since the Tax Cuts and Jobs Act went into effect, fewer filers itemize their deductions, but those itemized deductions begin to phase out above certain income levels. For 2023, the phase out begins for single filers with income above $182,100 and joint filers with income above $364,200. Most people will either not itemize deductions or will fall short of the income level that triggers the stealth tax.
There is a stealth tax on Social Security too and it hits a lot more people. From its inception in 1937 through 1983, Social Security was not taxed. Beginning in 1984 up to 50% became taxable, based on income. From 1994 onward the amount that was subject to federal income tax could be as high as 85%. Income thresholds where the tax would begin to set in were set in 83 and modified in 94 – but the amounts were deliberately not indexed for inflation.
To determine how much Social Security is taxable you add:
– ½ of your Social Security benefit;
– All other taxable income;
– Tax-exempt interest income.
Single filing status thresholds:
– If the total of the above items is less than $25,000, there will be no tax on SS benefits;
– If the total is between $25,000 and $34,000, up to 50% of SS will be taxable;
– If the total is over $34,000, up to 85% of SS will be taxable.
Joint filing status thresholds:
– If the total of the above items is less than $32,000, there will be no tax on SS benefits;
– If the total is between $32,000 and $44,000, up to 50% of SS will be taxable;
– If the total is over $44,000, up to 85% of SS will be taxable.
If the thresholds had been indexed for inflation they would almost have tripled by today! More and more Social Security recipient and paying more and more in taxes on their earned benefits.
But wait, there’s more! Medicare has a stealth tax attached to the cost of Part B premiums. Of course, they don’t call it a tax – it’s an Income Related Monthly Adjustment. The 2023 IRMAs appear below.
Single filing status | Premium
Less than $97,000 | $164.90
Between $97,001 and $123,000| $230.80
Between $123,001 and $153,000 | $329.70
Between $153,001 and $183,000 | $428.60
Between $183,001 and $500,000 | $527.50
Over $500,000 | $560.50
Joint filing status | Premium
Less than $194,000 | $164.90
Between $194,001 and $246,000 | $230.80
Between $246,001 and $306,000 | $329.70
Between $306,001 and $366,000 | $428.60
Between $366,001 and $750,000 | $527.50
Over $750,000 | $560.50
If you invest in the traditional TSP or in a traditional IRA, you get a tax break up front and tax deferred compounding. But, upon withdrawal, everything you withdraw from a traditional retirement investment is taxable at your rate for ordinary income. This could set you up for a stealth tax ambush.
If you are a way from the age where you will apply for Social Security or Medicare, there are ways you can avoid, or at least minimize, the stealth taxes. Consider Roth retirement investments. Qualified withdrawals from Roth IRAs or the Roth TSP are not taxable, so it will help lower your post-retirement income, thereby reducing, if not eliminating, your stealth tax. In addition, there are no required minimum distributions in Roth IRAs, and there will be no RMDs in the Roth TSP beginning in 2024.
Investing in taxable accounts could also help. With a taxable account you pay as you go, often at a lower rate (e.g., long-term capital gains, qualified dividends, etc.).
Roth investments are taxable up front, so you will want to watch your tax brackets when contributing to a Roth or to a taxable account. The same is true if you are considering converting a traditional IRA to a Roth IRA (you cannot convert from traditional to Roth within the TSP). You want to avoid moving up into another tax bracket. Fortunately, the brackets are relatively broad under current law.
Consider the future effects of stealth taxes when you make today’s investment decisions.
John Grobe, President of Federal Career Experts, is an expert in the area of federal employee retirement and benefits. This expertise comes from his 26 year federal career in which he managed the retirement program in a 3,500-employee office of a large federal agency.
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