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As we near retirement, we’re often told that we’ll pay less in taxes once we’ve retired. But is that always the case?
For some, yes, but for many, I would contend that you’ll pay just as much, if not more, in taxes in retirement than you did in your pre-retirement years.
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Others fail to seek tax advice as they near retirement and don’t plan proactively, resulting in the lack of a tax-efficient, long-term distribution strategy.
The complexity of tax laws and how they differ for various accounts and investments is another contributing factor to unforeseen tax liabilities.
Here are some financial aspects of retirement that can lead to a tax trap.
Your lifestyle
Most experts recommend planning to replace 75% to 85% of your pre-retirement annual income to maintain your current lifestyle. While expenses such as commuting or saving for retirement might drop, others, such as healthcare and leisure (travel, entertainment, hobbies, social activities, etc.), often increase.
Without a significant reduction in expenses, you’ll need to have an income similar to your later working years, likely keeping you in the same tax bracket.
Social Security
It’s calculated by adding your adjusted gross income (wages, interest, dividends, pensions, capital gains and retirement account withdrawals), nontaxable interest (typically, interest from tax-exempt bonds, such as municipal or government bonds) and half the total gross Social Security benefits received during the year.
That combination could create a “tax domino effect” if you withdraw money for living expenses and unintentionally trigger higher taxes on your Social Security.
Here are the income thresholds at which Social Security benefits become taxable:
|
Filing Status |
Annual Income |
Taxable Social Security Benefits |
|---|---|---|
|
Single |
Up to $25,000 |
0% |
| Row 1 – Cell 0 |
$25,001 to $34,000 |
Up to 50% |
| Row 2 – Cell 0 |
$34,001 or more |
Up to 85% |
|
Married, filing jointly |
Up to $32,000 |
0% |
| Row 4 – Cell 0 |
$32,001 to $44,000 |
Up to 50% |
| Row 5 – Cell 0 |
$44,001 or more |
Up to 85% |
Medicare
Medicare premiums can increase due to the income-related monthly adjustment amount (IRMAA). That’s an extra, income-based surcharge added to Medicare Part B (medical) and Part D (prescription drug) premiums for individuals with higher incomes.
For 2026, single tax filers with a modified adjusted gross income (MAGI) above $109,000 and joint filers above $218,000 are subject to IRMAA. The Social Security Administration uses tax returns from two years prior to determine if the additional fee applies.
Required minimum distributions (RMDs)
Those accounts include 401(k)s, 403(b)s, 457(b) plans, traditional IRAs, SEP IRAs, SIMPLE IRAs and Thrift Savings Plans (TSPs). The money you withdraw from those funds is considered taxable income.
The potential downside tax impacts of RMDs:
- They could potentially bump you into the next higher tax bracket
- They could increase your taxes on Social Security
- They could also increase your Medicare premiums due to IRMAA
Ways to help reduce the tax trap in retirement
How can you avoid paying unnecessary taxes in retirement? Here are a few strategies to consider.
1. Make Roth conversions (if appropriate).
A Roth IRA might be able to insulate you from future unknown taxes. Roth conversions are moving money from a pre-tax retirement account (such as a 401(k) or traditional IRA) into a Roth IRA.
You pay taxes on the amount you convert in the year you convert; the tradeoff is that you get tax-free growth and in retirement, withdrawals are tax-free. There’s no limit on how much you can convert.
A Roth conversion is a popular strategy to help reduce future tax burdens, especially for those expecting higher tax brackets later or wanting tax-free inheritance for their beneficiaries. There are no RMDs for the original owner of the account.
Because Roth withdrawals are tax-free, using funds in your Roth account in retirement can help prevent you from a higher tax bracket.
2. Consider using the low tax window before your RMDs start.
Some people will experience a drop in income when they retire. A prime time to begin withdrawing or converting assets is when you’re in a lower tax bracket.
Also consider that the next administration might increase taxes and make it more difficult from a yearly tax-rate perspective for some people to do such withdrawals or conversions.
Along with Roth conversions, here are other strategies to potentially take advantage of the low tax window:
- Consider early voluntary withdrawals. Start taking money out of IRA accounts after age of 59½ to lower the account balance and spread the tax liability over more years, rather than waiting for large, taxable RMDs.
- Balance tax brackets and IRMAA. Target a specific tax bracket in the years between retirement and RMDs to stay below higher tax brackets and avoid Medicare IRMAA surcharges.
- Consider qualified charitable distributions (QCDs). For those age 70½ and older, direct transfers from an IRA to a qualified charity can satisfy upcoming RMD requirements while reducing taxable income, even if you do not itemize deductions.
- “Fill” tax brackets. Purposefully take just enough income from tax-deferred accounts to reach the top of your current, lower tax bracket. You could end up paying less in taxes compared with the higher rates you might face when combined with future Social Security and RMDs.
3. Organize withdrawals by bucket.
In my experience, retirees often pull money from accounts in the wrong order, incurring tax consequences they could have otherwise avoided.
Taking too little from your tax-deferred accounts can lead to huge RMDs later in life. Taking too much early can increase your taxes and, potentially, your tax bracket.
It would be ideal to have a strategy that balances withdrawals from your taxable accounts, IRA (tax-deferred accounts) and Roth, while considering the income from Social Security and pensions.
The order in which you take withdrawals isn’t a hard-and-fast rule. A sensible approach is to have three buckets of money:
- Taxable (brokerage accounts)
- Tax-deferred (IRA/401(k), etc.)
- Tax-free (Roth)
Deciding which bucket to withdraw from depends on what’s going on in your life at that time.
Let’s say you’re married and filing jointly in the 12% tax bracket, which tops out at $100,800 of income for the 2026 tax year. Your taxable income for the year was close to that limit. You want to go on a cruise, and it’s going to cost $5,000. Should you pull that amount from your tax-deferred bucket? No.
In this example, it may be better to pull it from your Roth because it’s not taxable, and that $5,000 is not going to bump you into the next tax bracket.
Portfolio structure matters, especially in retirement.
- Consider placing tax-inefficient investments (e.g., taxable bonds, high-turnover funds) in tax-advantaged accounts, such as IRAs or 401(k)s
- Put tax-efficient investments (e.g., ETFs, index funds, municipal bonds) into taxable brokerage accounts
- Potentially avoid unnecessary capital gains, manage your dividends and distributions, and use tax-loss harvesting to offset capital gains and reduce tax burden
Review periodically and coordinate your plan
A retirement portfolio is not “set it and forget it.” Too many things can change year to year, so make sure to review your plan periodically and adjust it as needed.
Keep these priorities in mind when reviewing:
- Income changes
- Market shifts that can affect your portfolio
- New tax laws that can affect your lifestyle, taxation and withdrawals
- Health care cost adjustments
- RMDs and Social Security
Retirement tax planning should be geared toward reducing taxes and avoiding ugly surprises, helping ensure you keep more of what you’ve worked hard to build and save.
If you’re nearing retirement or already retired, it’s important to ask yourself: Am I heading toward a possible tax trap in my retirement?
The earlier you spot the tax trap, the easier it may be to avoid and ensure you can retire relaxed and happy.
Dan Dunkin contributed to this article.
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