The Social Security taxation trap

Up to 85% of your Social Security benefits can be taxable, depending on your "combined income" (your adjusted gross income plus half of your Social Security benefits plus any tax-exempt interest). If you're single and your combined income exceeds $34,000, or married and it exceeds $44,000, up to 85% of your benefits are taxable.

Here's the problem: every additional dollar of income you receive—from your RMD, your pension, your investment accounts—can cause more of your Social Security to become taxable. This creates a hidden marginal tax rate that's much higher than you think.

Let's say you're in the 22% federal tax bracket and you take an extra $10,000 distribution from your IRA. You'll pay 22% tax on that $10,000 ($2,200), but that $10,000 also causes an additional $8,500 of your Social Security to become taxable. At 22%, that's another $1,870 in taxes. So your $10,000 withdrawal actually cost you $4,070 in federal taxes—a 40.7% effective rate.

This is called the "tax torpedo," and most retirees have no idea it's happening. Your CPA sees it when they prepare your return, but by then it's too late to do anything about it.

What you can do: If you're still working part-time or have other income you can control, consider delaying Social Security until age 70 to maximize the benefit and reduce the number of years you're in the tax torpedo zone. If you're already taking Social Security, be strategic about where additional income comes from—Roth withdrawals don't count toward the combined income calculation, so pulling from a Roth IRA instead of a traditional IRA can keep more of your Social Security tax-free.

RMDs that push you into higher brackets (and trigger IRMAA surcharges)

Once you turn 73, the IRS forces you to take required minimum distributions from your traditional IRA, 401(k), and other pre-tax retirement accounts. The amount is based on your account balance and your life expectancy, and it increases every year.

For someone with a large IRA balance—let's say $2 million—the first-year RMD at age 73 is around $75,000. Combined with Social Security and a pension, that might push your taxable income from $120,000 to $195,000, moving you from the 22% bracket into the 24% bracket. And if it pushes you over the IRMAA threshold ($206,000 for married couples), you'll pay an extra $1,400+ per person per year in Medicare premiums.

The frustrating part is that you don't need the money. You're taking it because the IRS says you have to, and now you're paying a higher tax rate and higher Medicare premiums on income you didn't want in the first place.

What you can do (before RMDs start): Roth conversions in your 60s and early 70s—before RMDs kick in—can dramatically reduce future RMDs and keep you in lower tax brackets later. The earlier you start, the more time the Roth has to grow tax-free and the less you're forced to take out later.

What you can do (after RMDs start): If you don't need the RMD for living expenses, consider a Qualified Charitable Distribution (QCD). If you're over 70½, you can donate up to $100,000 directly from your IRA to charity. The distribution counts toward your RMD, but it's not included in your taxable income—so it doesn't push you into a higher bracket, doesn't cause more Social Security to be taxed, and doesn't trigger IRMAA.

Pension income that's not being tax-efficiently coordinated with other sources

Pension income is straightforward—it's taxed as ordinary income, just like wages. But when you layer it on top of Social Security and RMDs, it can create problems.

Let's say you have a $40,000 pension, $30,000 in Social Security, and a $60,000 RMD. That's $130,000 in income before you've taken a single dollar from savings to cover additional expenses. If you need another $30,000 for travel, medical costs, or helping your kids, where should that money come from?

If you pull it from your traditional IRA, you're adding $30,000 of ordinary income on top of everything else, pushing you deeper into the 24% bracket (or higher). If you pull it from your Roth IRA, it's tax-free and doesn't affect your bracket, your Social Security taxation, or your IRMAA calculation. If you pull it from a taxable brokerage account, you're paying capital gains rates (likely 15%), which is better than ordinary income but not as good as Roth.

Most retirees don't think about this—they just pull money from wherever is convenient. But the account you choose can make a $5,000-$10,000 difference in your annual tax bill.

What you can do: Map out your income sources and model the tax impact of different withdrawal strategies. In years where your income is already high (big RMD, high pension), pull additional spending money from Roth or taxable accounts. In years where your income is lower (maybe your pension has a COLA adjustment or you delay taking the RMD until later in the year), you might take extra from your IRA to "fill up" a lower bracket.

Estimated tax payments and withholding

When you're taking income from multiple sources, it's easy to underpay your taxes throughout the year and get hit with a big bill (and possibly penalties) when you file. The IRS expects you to pay taxes as you earn income, either through withholding or estimated quarterly payments.

Most pensions withhold taxes automatically, but the default withholding might not be enough once you layer in RMDs, Social Security, and investment income. Social Security withholds taxes if you ask them to, but many retirees don't. RMDs can have taxes withheld, but if you're taking monthly distributions, the withholding might not keep pace with your actual liability.

If you underpay by more than 10%, you owe penalties—even if you pay the full amount when you file your return in April. The IRS doesn't care that you didn't know; they just want their money throughout the year.

What you can do: Work with your CPA to project your total tax liability for the year, then adjust your withholding or make estimated payments to cover it. One strategy is to have extra tax withheld from your RMD toward the end of the year—withholding is treated as if it was paid evenly throughout the year, so a large withholding in December can cover earlier quarters and help you avoid underpayment penalties.

The sequence of income withdrawals matters

If you're still in the early years of retirement and you have flexibility on when to start Social Security, when to take your pension, and how much to pull from IRAs, the order in which you turn on these income sources can have a huge impact on your lifetime taxes.

Common mistake: Taking Social Security at 62, starting the pension immediately, and letting the IRA grow until RMDs start at 73. This seems logical—delay the tax hit on the IRA for as long as possible. But what actually happens is that you're in a low tax bracket for 10 years (just Social Security and pension), then at 73 you're forced to start taking RMDs that push you into a much higher bracket for the rest of your life.

Better strategy: Delay Social Security until 70 (if you can afford to), take the pension if you need it, and use the years between retirement and age 73 to do Roth conversions or take strategic IRA withdrawals while you're in a lower bracket. By the time RMDs start, your IRA balance is lower, your RMDs are smaller, and you stay in a lower bracket throughout retirement.

This requires planning years in advance, but the tax savings are significant—potentially $100,000+ over a 20-30 year retirement.

Are you missing deductions or credits available to retirees?

Most retirees take the standard deduction because their mortgage is paid off and they don't have enough itemized deductions to exceed it. But there are strategies to create deductions that reduce your taxable income:

Charitable contributions: If you're charitably inclined, bunching multiple years of donations into a single year using a donor-advised fund can push you over the standard deduction threshold in that year, saving you taxes. Or use QCDs from your IRA (if over 70½) to satisfy your RMD without adding to your taxable income.

Medical expenses: If you have significant unreimbursed medical expenses (7.5% of AGI threshold), bunching them into a single year can make them deductible. This might mean scheduling elective procedures or paying for long-term care insurance premiums in a year where you're already over the threshold.

State and local taxes: The SALT deduction is capped at $10,000, but if you're paying property taxes and state income taxes, make sure you're at least claiming up to the cap.

Most retirees don't optimize for deductions because they assume the standard deduction is always better. But with planning, you can alternate between years where you itemize (by bunching deductions) and years where you take the standard deduction, lowering your average tax rate over time.

What to do about it

If you're taking RMDs, Social Security, and a pension, your taxes are more complex than they were during your working years—but most retirees treat them as if they're simpler. The strategies that reduce your tax bill require looking at all your income sources together, modeling different scenarios, and making coordinated decisions about where to pull money from and when.

Your CPA can prepare your return and tell you what you owe. Your financial advisor can manage your investments and calculate your RMD. But unless someone is coordinating across all of it—modeling the Social Security taxation impact, watching for IRMAA cliffs, timing withdrawals to minimize taxes, and planning QCDs or Roth conversions—you're probably paying more than you need to.

If you're taking income from multiple sources and want to make sure you're not overpaying on taxes, let's talk.