Key Takeaways
- Retirement income from sources such as Social Security, retirement accounts, pensions, and investments is taxed differently from regular W-2 wages.
- New retirees may underestimate how multiple income streams can interact to potentially increase their taxable income, tax bracket, or Medicare premiums.
- Mistakes like missing required minimum distributions (RMDs) and not accounting for tax withholdings on your retirement income can result in costly penalties.
- Strategic withdrawal planning—including well-timed Roth conversions and investment sales—can help reduce long-term tax exposure.
- Ongoing coordination with a qualified tax professional can help retirees avoid tax-time surprises and preserve more of their savings.
Many retirees assume their taxes will go down once they stop working because they’re no longer earning regular wages. In reality, the first several years of retirement are often when costly tax mistakes happen.
Social Security benefits, retirement account withdrawals, pensions, and investment dividends are all taxed differently, and how (and when) you draw from them can affect everything from your marginal tax bracket to your Medicare premiums. Here are six of the most common tax filing mistakes retirees make, along with practical steps to avoid them.
1. Missing or Miscalculating Required Minimum Distributions (RMDs)
Required minimum distributions (RMDs) generally begin at age 73. Once you reach that age, the IRS requires you to withdraw a minimum amount each year from most tax-deferred retirement accounts, including traditional IRAs and 401(k)s.
One of the most costly mistakes retirees make is forgetting to take an RMD, miscalculating the amount, or overlooking an old account altogether.
“Missing RMD deadlines … can trigger a large tax penalty on the amount not withdrawn,” said David Meyer, managing principal of Meyer Wilson Werning Co., LPA.
The current penalty is a 25% excise tax on the amount you failed to withdraw. Although that penalty can be reduced to just 10% if it’s corrected within two years, this penalty can still be a significant and avoidable hit to your retirement savings.
How to Avoid It
List out all of your retirement accounts that are subject to RMDs and verify the required annual withdrawal amount. Consider setting up automatic distributions to avoid missing deadlines.
It may also help to make strategic withdrawals in the years leading up to age 73 to reduce the size of future RMDs.
“The years between retirement and age 73 often create a strategic window for planned withdrawals … to reduce long-term tax exposure,” explained Karla Dennis, an enrolled agent and CEO of KDA, Inc.
If you’re unsure whether you’ve calculated your RMD correctly, confirm the amount with a qualified tax professional before year-end.
Important
RMDs generally apply to traditional IRAs and most workplace retirement plans. However, Roth 401(k)s are no longer subject to required minimum distributions during the original owner’s lifetime.
2. Misunderstanding How Social Security Benefits Are Taxed
Much to the surprise (and disappointment) of some new retirees, Social Security benefits are not automatically tax-free.
“Portions of Social Security benefits are often taxable, particularly when combined with pension income or IRA withdrawals,” said Meyer.
According to the IRS, 50 to 85% of a retiree’s Social Security benefits may be taxable if their total income, which includes their benefits plus part-time wages, pensions, interest, dividends, and capital gains, exceeds certain thresholds ($25,000 for single filers and $32,000 for married couples filing jointly).
Depending on your total income, Social Security benefits can push you into a higher tax bracket and increase the taxable portion of those benefits.
How to Avoid It
Calculate your combined income each year before making large withdrawals. Coordinate distributions from retirement accounts with your Social Security benefits to avoid crossing key thresholds unnecessarily, especially before you are subject to RMDs. Working with a tax professional to model different withdrawal scenarios can help reduce surprises and give you the optimal tax outcome.
3. Failing to Adjust Tax Withholding After Retirement
According to Dennis, the biggest mistake soon-to-be retirees make is failing to model what their income and taxes will look like after their paychecks—and the automatic withholdings that come with them—stop.
“Once wages stop, withholding often drops unless you intentionally elect withholding on distributions or make estimated payments,” she said.
While retirees may assume that taxes will simply be taken out of Social Security or pension payments in sufficient amounts, withholding on retirement income is often lower than what’s needed. Some income sources, like Roth IRA withdrawals or investment income, may not have any taxes withheld unless you request it.
This means you may unintentionally underpay throughout the year and face IRS penalties when you file your taxes.
“Underpayment penalties often happen simply because retirees don’t realize how pensions, Social Security, and IRA withdrawals are taxed differently than wages,” Meyer said.
How to Avoid It
Taxpayers generally must pay at least 90% of their current-year tax liability or 100% of last year’s tax (or 110% if your prior-year AGI was over $150,000). To do this, review all expected income sources before the start of each tax year and estimate your total tax liability.
If you receive Social Security benefits, you can request federal withholding by submitting Form W-4V. You can also elect to have withholding applied to pension payments or retirement account distributions.
If withholding won’t be sufficient, consider making quarterly estimated tax payments to the IRS. Meyer advised coordinating with a CPA before your first year of retirement to help prevent unexpected liabilities and costly penalties.
Important
The income thresholds that determine whether Social Security benefits are taxable ($25,000 for single filers and $32,000 for joint filers) are not indexed for inflation. As other income rises over time, more retirees may find their benefits partially taxable.
4. Overlooking Taxes on Investment Income
Dividends, interest, and capital gains are all potentially taxable, even if you’re no longer earning wages.
“Selling appreciated assets to fund retirement can unexpectedly push income higher and create ripple effects across their entire return,” Dennis noted.
Those ripple effects can include moving into a higher tax bracket, increasing the taxable portion of Social Security benefits, or triggering higher Medicare premiums through income-related monthly adjustment amounts (IRMAA).
Even qualified dividends and long-term capital gains, which are often taxed at lower rates, can add up quickly if multiple assets are sold in the same year.
How to Avoid It
Before selling investments, review your cost basis and estimate the impact on capital gains. Consider spreading large sales over multiple tax years to avoid stacking income into a single year. You can also potentially reduce your tax burden by selling investments at a loss to offset your capital gains (also known as tax-loss harvesting).
Warning
Medicare Part B and Part D premiums are based on your modified adjusted gross income from two years prior. A large Roth conversion or investment gain today could raise your Medicare costs in the future.
5. Converting Too Much to a Roth IRA at Once
Roth IRA conversions can be a powerful retirement tax strategy, but they can also backfire if not carefully planned.
The goal of converting money from a traditional IRA to a Roth IRA is typically to reduce future RMDs or lock in today’s tax rates. However, a large conversion can push you into a higher tax bracket and/or increase the taxable portion of your Social Security benefits, since the amount converted is treated as taxable income in that year.
These conversions can also unintentionally trigger higher Medicare Part B and Part D premiums through IRMAA surcharges. Because Medicare premiums are based on income from two years prior, retirees may not immediately connect a Roth conversion to a later premium increase.
How to Avoid It
Instead of converting a large balance all at once, consider spreading Roth conversions over multiple years to stay within a targeted tax bracket. Like strategic retirement withdrawals, Dennis said the ideal time to do these conversions is between your initial retirement and age 73, before RMDs kick in.
Working with a tax professional to coordinate Roth conversions with other income sources can help you maximize the long-term benefit while minimizing unintended consequences.
6. Forgetting to Report Part-Time or Gig Income
Many retirees take on consulting work, freelance projects, part-time jobs, or other side gigs to stay active or supplement their income. But even small amounts of earned income can carry tax consequences that retirees don’t fully anticipate.
Unlike other types of income, contract and gig work are subject to both regular income taxes and self-employment taxes, which cover Social Security and Medicare contributions. Even if you have a part-time W-2 job with automatic tax withholding, modest earnings can affect the taxation of Social Security benefits or increase Medicare premiums if they push total income above certain thresholds.
How to Avoid It
Before starting any post-retirement work, review how additional income will affect your overall tax picture. Keep detailed records of all part-time or gig income and track related expenses, which may help reduce taxable income through deductions.
You should also set aside a portion of each payment—usually 20 to 30%, depending on your tax bracket—to cover income and self-employment taxes. If necessary, make quarterly estimated tax payments to avoid penalties.
The Bottom Line
Retirement changes how you earn income—and how you’re taxed. What worked during your working years may no longer apply once Social Security, retirement account withdrawals, and investment income replace your paycheck. Reviewing your income sources annually and working with a qualified tax professional can help you avoid penalties, manage Medicare premiums, and preserve more of your retirement savings.
“Retirement is not just a life change,” said Dennis. “It is a tax transition. The retirees who do best are the ones who engage in advance retirement tax planning and continue to monitor the taxability of their income year over year.”
