3 Common Retirement Tax Traps to Avoid
Your retirement income decisions have tax implications that can surface years later. Learn to navigate the rules that link your withdrawals to future costs.
While retirement planning often focuses on accumulating savings, navigating the complex tax rules during decumulation presents a significant challenge. Understanding these potential pitfalls is a part of preserving wealth throughout retirement. With careful planning, retirees can anticipate these issues and structure their finances to mitigate their impact.
The Social Security Tax Torpedo
A reality for many new retirees is that their Social Security benefits may be subject to federal income tax. The mechanism determining this is often called the “Social Security tax torpedo” because of how quickly it can increase tax liability. The trap lies in a specific IRS calculation for “provisional income” or “combined income,” which must be figured separately to determine the tax treatment of your benefits.
Provisional income is calculated by taking your Adjusted Gross Income (AGI), adding any nontaxable interest, and then adding 50% of your total Social Security benefits for the year. This figure is compared against two income thresholds that have not been adjusted for inflation since their introduction. These fixed thresholds cause the “torpedo” effect, as modest retirement income can push a household into having their benefits taxed.
For a single filer, provisional income below $25,000 means Social Security benefits are tax-free. If income is between $25,000 and $34,000, up to 50% of benefits may be taxable. Provisional income exceeding $34,000 can result in up to 85% of benefits being subject to income tax. For married couples filing jointly, the thresholds for 50% and 85% taxability are $32,000 and $44,000.
Consider a married couple with an AGI of $35,000 from pensions and IRA withdrawals and $30,000 in Social Security benefits. Their provisional income is $35,000 (AGI) plus $15,000 (50% of Social Security), totaling $50,000. Because this amount is above the $44,000 threshold, up to 85% of their Social Security benefits become taxable income.
The Required Minimum Distribution Penalty
Tax-deferred retirement accounts like traditional IRAs and 401(k)s require account holders to begin taking withdrawals, known as Required Minimum Distributions (RMDs). These distributions ensure that taxes are eventually paid on the savings. Under current law, individuals must begin taking RMDs at age 73.
The trap associated with RMDs is the penalty for non-compliance. Failing to withdraw the full required amount by the deadline results in a federal excise tax. The penalty is 25% of the amount that should have been withdrawn but was not. This is a significant reduction from the previous 50% penalty, but it remains a substantial financial consequence.
If a missed RMD is corrected in a timely manner, the penalty can be reduced to 10%. The RMD amount is calculated annually by dividing the account’s prior year-end market value by a life expectancy factor from the IRS’s Uniform Lifetime Table. While Roth IRAs are exempt from RMDs for the original owner, a 2024 change now also exempts designated Roth accounts within 401(k) plans.
While the RMD must be calculated for each separate IRA, the total RMD amount for all IRAs can be withdrawn from a single account. This flexibility does not apply to 401(k) or 457(b) plans, where the RMD must be taken from each account. The first RMD can be delayed until April 1 of the year after an individual turns 73, but this requires taking two RMDs in that tax year.
The Medicare Premium Surcharge
An unexpected cost in retirement can come from Medicare itself. Higher-income beneficiaries must pay an additional amount for their Part B and Part D premiums, a surcharge known as the Income-Related Monthly Adjustment Amount (IRMAA). It functions as a “cliff” system, where even one dollar of income over a set threshold can trigger hundreds of dollars in additional annual premiums.
The core of this trap is the two-year look-back period. The Social Security Administration (SSA) determines your IRMAA for the current year based on the Modified Adjusted Gross Income (MAGI) from your tax return filed two years prior. For example, 2025 Medicare premiums are determined by your 2023 MAGI. This delay means a one-time high-income event, like a large IRA withdrawal or asset sale, can cause a premium increase two years later.
The MAGI calculation for IRMAA starts with your AGI and adds back certain tax-exempt income, such as interest from municipal bonds. For 2025, IRMAA surcharges begin for individuals with a 2023 MAGI over $106,000 and for joint filers with a MAGI over $212,000. The standard Part B premium for 2025 is projected to be $185.00 per month, with surcharges adding to this cost.
The income thresholds are tiered. For example, based on 2023 income, a single filer with a MAGI between $106,001 and $133,000 will pay an extra $74.00 per month for Part B in 2025. This surcharge rises with income to a maximum of $443.90 per month for individuals with a MAGI of $500,000 or more. If a life-changing event like retirement causes your income to decrease, you can appeal the IRMAA determination by filing Form SSA-44.