Common Tax Mistakes in Retirement

Retirement means financial freedom, but it also brings new tax complications that catch many people by surprise.

The strategies that saw you through your earning years often don’t apply when you’re living on savings, pensions, and Social Security.

Minor oversights can cost you thousands in unnecessary taxes, while simple planning moves can keep significantly more money in your pocket.

Here are the most common tax mistakes retirees make and how to avoid them.

Ignoring required minimum distributions

Once you hit 73, the IRS demands that money come out of traditional IRAs and 401(k) accounts-even if you don’t need it.

If you fail to meet this deadline, you’ll be charged 25 percent of what you should have withdrawn.

Many retirees forget about their old employer accounts or miscalculate what they owe, leaving them vulnerable to costly surprises.

The calculation is based on your account balance and life expectancy—the percentage increases with age.

These forced withdrawals then push income higher, potentially raising tax brackets, Social Security taxation, and Medicare premiums.

The best ways to minimize the impact of RMDs are to plan for them years in advance through either strategic withdrawals or Roth conversions.

Withdrawing from accounts in the wrong order

The order of tapping into these retirement accounts substantially determines your tax bill over time.

Most financial advisers recommend taking distributions from taxable accounts first, then from tax-deferred accounts, and finally from Roth accounts.

This strategy allows the tax-advantaged accounts to grow longer while minimizing taxes now.

Each situation is unique in terms of income needs, account balances, and tax brackets.

A person who has large traditional IRA balances may be well off taking withdrawals early to avoid the huge RMDs in later years.

Others, with pension income, may delay Social Security and live off Roth conversions.

The wrong sequence can mean paying higher taxes throughout retirement than necessary with better planning.

Missing Roth conversion opportunities

Converting traditional IRA money to Roth accounts creates a tax bill now but eliminates future required distributions and taxes on growth.

The years between retirement and age 73 often offer ideal conversion windows when income drops but before RMDs begin.

Many retirees miss this window entirely, or convert too little to make a meaningful impact.

The approach is to convert enough each year to fill your current tax bracket without exceeding the next one.

Done systematically over a number of years, conversions can drastically reduce lifetime tax.

The converted amounts grow tax-free forever and do not count toward RMDs, affording you greater control of future tax situations.

Professional guidance helps you determine optimal conversion amounts based on your circumstances.

Social Security taxation is overlooked

Most retirees believe that Social Security benefits are not subject to taxation, but in fact, up to 85 percent of them are taxable, depending on the combination of income.

This is done based on the combined income, which includes adjusted gross income, nontaxable interest, and half of Social Security benefits.

There are sudden thresholds beyond which benefits become taxable, taking people by surprise.

Understanding this taxation helps with planning other sources of income.

Sometimes, delaying Social Security while living on IRA withdrawals or Roth conversions results in lower lifetime taxes.

Other times, it makes sense to take Social Security early and convert traditional IRAs to Roths.

The best option will differ for everyone, depending on your overall financial situation, not just on maximizing the benefit amounts.

Not planning for Medicare surcharges

The Medicare Part B and Part D premiums rise with modified adjusted gross income two years earlier.

These Income-Related Monthly Adjustment Amounts can add several hundred dollars to premiums each month when income exceeds certain thresholds.

Large IRA withdrawals, Roth conversions, or capital gains can trigger surcharges two years later.

The income brackets that create these surcharges are not indexed for inflation, so that retirees will be affected over time.

A one-time large withdrawal may seem manageable until the Medicare surcharge hits 24 months later.

Planning significant income events carefully, spreading them across years, or timing them before Medicare enrollment helps minimize or avoid these additional costs.

Not withholding enough from distributions

Unlike paychecks, automatic withholding isn’t available for retirement account distributions; you must opt for tax withholding.

Many people select zero withholding to maximize current cash flow, only to be assessed large tax bills at filing.

This can lead to both financial shock and possible underpayment penalties if quarterly estimated payments are not made.

A better strategy is to estimate how much you will owe in taxes for the year and have that amount withheld from pensions, Social Security, or IRA distributions.

You can change withholding amounts at any time, so this is more flexible than quarterly estimated payments.

Paying your taxes through withholding also avoids underpayment penalties, even if the money comes out late in the year.

Missing qualified charitable distribution benefits

After you reach age 70½, you may transfer up to $100,000 each year directly from IRAs to qualified charities.

These qualified charitable distributions are treated as required minimum distributions but do not increase adjusted gross income.

This gives charitably inclined retirees better tax benefits than taking the distribution and donating separately.

The QCD strategy works exceptionally well for those taking the standard deduction who wouldn’t otherwise benefit from charitable deductions.

The reduced adjusted gross income helps to avoid the taxation of Social Security, Medicare surcharges, and other income-based thresholds—many retirees who consistently give to churches or nonprofits never learn about this advantageous option.

Ignoring state tax differences

Some retirees are moving to traditional retirement destinations without doing their homework on state tax treatment of their retirement income.

Nine states do not have any income tax at all, while others exempt Social Security and pension income or provide a deduction for retirement income.

Moving to the wrong state will cost you thousands each year.

Besides income taxes, other important considerations include property taxes, sales taxes, and estate taxes.

For instance, a state that doesn’t charge any income taxes may impose crushing property taxes that nullify any savings.

Some states fully tax distributions from retirement accounts while exempting pension income, making the analysis complicated quickly.

Changing residences takes time, and moving back is costly, so do your research before making a decision.

Bunching deductions improperly

Since the standard deduction for those 65 and older is higher than it is for younger taxpayers, fewer people will find it worthwhile to itemize.

This creates opportunities to bunch deductions—concentrating charitable giving, medical expenses, and state tax payments into alternating years so you can exceed the standard deduction periodically.

You maximize deductions in the years you itemize, and in off years you take the standard deduction and minimize deductible spending.

This strategy requires planning over two-year segments but can save significant taxes compared with spreading expenses equally.

It also works exceptionally well when combined with qualified charitable distributions in alternate years.

Forgetting to take advantage of tax-loss harvesting

Investment losses can offset gains and up to $3,000 of ordinary income annually, with excess losses carrying forward indefinitely.

Tax-loss harvesting is one of the most overlooked strategies by retirees since many think it’s only for working people with high incomes.

However, strategic harvesting creates losses that offset required minimum distributions, pension income, or Social Security taxation.

The strategy involves selling investments at a loss while simultaneously buying similar but not identical securities to maintain market exposure.

Harvested losses accumulate and offset future gains or provide modest annual deductions against ordinary income.

In retirement, every deduction helps manage the various income thresholds affecting benefits and premiums.

Taxation of reinvested dividends

Dividends in taxable accounts spawn tax bills whether you spend them or reinvest them.

Many retirees do not realize they are paying taxes on income they never earned.

Meanwhile, qualified dividends are taxed at preferential rates, which many retirees could avoid entirely by carefully managing their income.

Understanding the difference between qualified and ordinary dividends helps select and locate investments.

Tax-free interest from municipal bonds is an appealing option in taxable accounts for retirees in higher tax brackets.

The use of dividend-paying stocks in IRAs or Roth accounts avoids annual taxation of dividends; this requires planning before one retires and may involve moving the accounts around.

Not maximizing standard deductions

The higher standard deduction for seniors eliminates the need for many retirees to itemize, yet many continue to track expenses and file Schedule A for no benefit.

Alternatively, some retirees are missing opportunities to time their income and deductions around the standard deduction to reduce taxes.

If your deductions almost reach the standard amount, you’re losing money if you don’t bunch them into alternating years.

If your regular deductions are considerably more than the standard amount, you have less leeway with timing.

Knowing where you are helps you optimize your tax planning without unnecessary recordkeeping.

Missing elderly tax credits

Tax credits for the elderly and disabled provide benefits for low-income retirees that many never claim.

The credit phases out for higher-income earners, but those who qualify could receive several thousand dollars.

The calculations are complex, which may explain why eligible people overlook them.

Other state tax credits available for seniors include property tax credits, pharmaceutical assistance, and utility bill credits.

These are not, strictly speaking, federal tax items, but they work similarly as a reduction in the amount owed.

Researching the federal and state programs available to seniors often reveals benefits that can be claimed.

Underestimating required estimated payments

Retirees receiving income from sources that don’t withhold, including rental properties, part-time consulting, and investment income, must make quarterly estimated payments.

Underestimating those payments can lead to penalties and interest, even if you pay up when you file.

The so-called safe harbor rules offer some protection, but many retirees miscalculate or fail to make the payments.

The easiest way is to pay 100 percent of last year’s tax liability in four quarterly installments, or 110 percent if you’re high-income.

This safe harbor will protect you from penalties regardless of changes in your income this year.

You can also calculate the actual quarterly liability, which works well if your income is predictable, but it’s more work and riskier if you underestimate.

The retirement tax landscape

Tax planning matters more in retirement than during working years for many people, as income becomes more controllable.

You decide when to tap which accounts, when to realize gains, when to convert to Roth, and when to start Social Security.

Each decision ripples through your tax return and impacts other benefits and costs.

The mistakes we outline in this chapter are not at all intuitive, and very often even conscientious retirees fail to seize opportunities or trigger unintended consequences.

Professional tax advice focused on retirement usually pays for itself many times over through strategies that reduce lifetime taxes.

Chances are, your retirement years outnumber your working years at this point, so how you efficiently approach taxes in that timeframe is a major determining factor in how long your money will last.