Income Stacking & The "Tax Torpedo"

Retirement taxes work differently than specialized wage taxes. Your income sources "stack" on top of each other, and adding one type of income can unexpectedly increase the taxes on another.

Visualizing the Effect

The chart below illustrates three scenarios. Notice how the Purple Bar (Taxable SS) acts like a multiplier effect when you add other income.

Key Takeaway: Even if Capital Gains (Green) are taxed at 0%, adding them increases your total income. This pushes your Social Security (Purple) across the "taxable threshold," effectively creating a tax where there was none before.

1. The Stacking Order

The IRS considers your income in a specific order:

Bottom Layer: Ordinary Income (Wages, Pensions, IRA withdrawals). This fills up your Standard Deduction first.
Middle Layer: Taxable Social Security. This grows dynamically based on your total income.
Top Layer: Long-Term Capital Gains. These sit on top tax-free (at 0%) until your total income crosses roughly $47k (Single) or $94k (Married).

2. The "Tax Torpedo"

The "Torpedo" is the phenomenon where adding $1 of income causes more than $1 of taxable income.

If you are in the Provisional Income Zone ($25k-$34k Single, $32k-$44k Married), every $1 you withdraw from an IRA forces $0.85 of your Social Security to become taxable.

Result: You pay tax on $1.85, creating a marginal tax rate that is 1.85x higher than your bracket!