Common Tax Traps To Avoid In Retirement

Summary/TL;DR

The Social Security Tax Torpedo, IRMAA surcharges, and Required Minimum Distributions (RMDs) are all tax traps which retired taxpayers commonly fall victim to. Furthermore, additional traps lie in simply being unaware of certain provisions which can prevent you from paying more tax than is necessary, such as Qualified Charitable Distributions (QCDs) and the Premium Tax Credit. All of these provisions, and many more, are interconnected and constantly changing, making their avoidance best navigated by a team of competent and knowledgeable professionals.

Introduction

Once you retire, your tax picture changes for the rest of your life. If you don’t know what you are doing, you will pay far more in tax than is necessary. Familiarity with these tax-code provisions alongside a robust tax plan, however, can save you and your family a small fortune in tax savings.

Today’s post will discuss a few of the more common tax traps and how they can be avoided.

The Social Security Tax Torpedo

The so-called Social Security Tax Torpedo refers to a common tax trap in which more of one’s Social Security benefits are subject to taxation due to the unique nature by which they're taxed. I’ve written in detail about the social security tax torpedo here.

There will never be a circumstance in which more than $0.85 of any dollar you receive from Social Security will be included in your taxable income. What determines how much between 0% and 85% of your Social Security is taxed is determined by your provisional income, which is closely related to your Adjusted Gross Income (AGI). The higher your provisional income, the more of your Social Security will be included in your taxable income, up to the cap of 85%. The visual below shows how this structure can easily lead to a cycle in which a dollar of additional AGI produces a disproportionately large increase in taxable income.

Since provisional income is closely related to AGI, the logical way to avoid this tax trap is by keeping your AGI within ranges that keep your provisional income low. This can easily be accomplished through pursuit of a tax-diversified portfolio and distribution plan, although implementation of such a plan is difficult to manage without the assistance of a professional.

The IRMAA Surcharge

IRMAA is a surcharge on Medicare Part B and Part D premiums that become effective once one’s Modified Adjusted Gross Income (MAGI) exceeds certain thresholds. I’ve written in detail about IRMAA here. The IRMAA brackets for 2025 are below:

IRMAA is commonly triggered during years when large Roth conversions are made or once Required Minimum Distributions (RMDs, discussed below) begin. Widows, in particular, are at risk in this later case, as they are filing taxes as Single taxpayers. Finally IRMAA operates on a two-year lookback, meaning that your income from two years ago will be used to determine if IRMAA applies to you this year.

IRMAA can easily be avoided through proactive tax planning, although triggering it might be unavoidable in some instances. Fortunately, as long as your income comes back down, the surcharge will be temporary.

Required Minimum Distributions

Required Minimum Distributions (RMDs) are mandatory distributions from pre-tax retirement accounts (such as Traditional IRAs and 401(k)s) that begin at one’s age 73-75. I’ve written in detail about RMDs here.

RMDs can throw a huge wrench in your tax plan if they aren’t properly planned for. For example, if you have $2,000,000 in a Traditional IRA when you turn 75, you will be required to distribute about $80,000 from that account, all of which will be taxable as ordinary income. Furthermore, your RMD will grow considerably as you age and your account continues to grow. Given what we know about the Social Security Tax Torpedo and IRMAA Surcharges discussed above, it’s easy to imagine the consequences of large RMDs reaching beyond themselves. And like the IRMAA Surcharge, widows are uniquely at risk to be negatively affected by RMDs because they will be filing taxes as Single taxpayers.

Common strategies for mitigating RMDs include pursuing a strategy of tax diversification by making Roth conversions and saving into both Roth and non-qualified brokerage accounts during your working years. Qualified Charitable Distributions (QCDs, discussed below) are another type of transaction that can minimize the effect of RMDs.

Missing Opportunities

Perhaps the most common “trap” that taxpayers fall victim to is simply being unaware of certain tax provisions. It’s like the old saying goes: “You don’t know what you don’t know”. A couple of common examples of these are provided below, but keep in mind that this, like the above, is by no means an exhaustive list.

Qualified Charitable Distributions

Qualified Charitable Distributions (QCDs) are a type of transaction in which IRA distributions are sent directly to a qualified public charity. I’ve written in detail about QCDs here.

QCDs are one of only a few ways to make a tax-free distribution from your Traditional IRA. If done correctly, the distribution will not be taxable in the year it was made and can be used to satisfy your RMD.

The Premium Tax Credit

The Premium Tax Credit is a tax credit that can greatly alleviate the high cost of securing health insurance in the years before Medicare eligibility. I’ve written in detail about the Premium Tax Credit here.

Unfortunately, the calculation of the Premium Tax Credit is relatively complex and well beyond the scope of this piece. What’s important is to understand how it can serve you in retirement. In short, if you are younger than 65 when you retire and purchase health insurance through a private exchange, then the Premium Tax Credit could save you thousands, and oftentimes tens-of-thousands, of dollars in medical insurance premiums annually. Once you turn 65 and get on Medicare, however, it no longer becomes relevant.

Putting It All Together

The tax code contains multiple provisions that are interconnected and under constant flux. As can be imagined, keeping track of all of these tax traps can be daunting. Furthermore, inexperience in attempting to navigate these matters is more likely to lead to mistakes that will exacerbate their effects. A competent and knowledgeable financial planner, in conjunction with a proactive CPA, can go a long way towards taking these things off of your plate, leaving you with more time and energy to focus on what you love (while also saving you and your family a small fortune in taxes!)