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How can tax rates be higher in retirement than your earning years?

Ask an advisor: How can tax rates be higher in retirement than your earning years?

I recently attended a retirement seminar at a local community college where the instructor talked about potentially higher tax rates in retirement due to the new RMD age. Throughout my savings career, I have been under the impression that tax rates should decrease in retirement, especially if you pace your withdrawals. How can tax rates in retirement be higher than your earning years?


Let’s start with the simplest answer and build from there. Required minimum distributions (RMDs) are certainly one reason a person’s tax rate will increase in retirement, but they are not the only reason. There are a number of possible scenarios in which someone could face higher taxes in retirement compared to their earning years. (And if you need help planning for taxes in retirement, consider consulting a financial advisor.)

New RMD rules could lead to higher taxes

Under the SECURE 2.0 Act, the age at which required minimum distributions (RMDs) begin increased from 72 to 73 in 2023. With that change, any pre-tax money invested in a 401(k) will have an extra year to grow before you have to withdraw the money. This means you could have a larger balance to distribute each year once the RMDs take effect, and therefore a larger tax bill.

Please note that the RMD age will increase to 75 years in 2033. As a result, anyone who turns 75 that year or later can invest their savings for an additional three years compared to the previous rules. More time in the market could mean an even larger balance to distribute each year. These larger distributions could potentially push you into a higher tax bracket. (And if you need help planning RMDs, consider talking to a financial advisor.)

Larger benefit payments can also trigger Medicare’s income-based monthly adjustment amount (IRMAA), leading to higher monthly premiums for Medicare Parts B and D.

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Ask an advisor: How can tax rates be higher in retirement than your earning years?Ask an advisor: How can tax rates be higher in retirement than your earning years?

Ask an advisor: How can tax rates be higher in retirement than your earning years?

Many retirees who have earned a healthy salary and saved a lot are surprised to discover that their income can actually increase after retirement. Although up to 85% of Social Security benefits are taxable, the combination of these payments and retirement account withdrawals can provide significant income. Add in retirement income, taxable investments, rental income and part-time work, and a retiree can find themselves in a higher tax bracket than during their primary earning years.

Inheriting pre-tax money can also increase income in retirement, as inherited IRAs have a ten-year period to be fully distributed. In other words, the entire amount of the inherited IRA will be added to the beneficiary’s income within ten years. (And if you need help managing your income streams in retirement, this tool can help match you with a financial advisor.)

The ‘widow(er)’ tax

The widow’s tax is an often overlooked tax increase that impacts married couples when the first spouse dies. In retirement, the death of a spouse often does not result in a significant drop in income. But the surviving spouse’s retirement income now falls into the “single” tax bracket, rather than the much preferred “married filing jointly” bracket.

For a married couple with $50,000 in taxable income, this could increase taxes by almost $1,000 each year. For a married couple with an income of $100,000, the tax increase would be closer to $5,000. (A financial advisor can help you navigate financial changes that could impact your tax situation.)

Large one-time costs

A retiree may plan to distribute their pre-tax benefits evenly over time, but life rarely goes exactly as planned. People may pay higher taxes during retirement during years when large distributions must be withdrawn from a pre-tax account to cover one-time expenses. Hopefully that distribution is for something fun, like an RV or a trip with the grandkids, but it may also be necessary to pay for a new roof or long-term care. In either case, taking a lump sum distribution will increase your income tax bill and IRMAA for that year.

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Changes in the tax law

The tax code is written in pencil. While some provisions of the tax code seem less popular to adjust, none are set in stone. We already know that tax rates will increase in 2026 following the passage of the Tax Cuts and Jobs Act (TCJA), so it’s a matter of “when” and not “if.” Historically, tax rates are at historically low levels, so it is also understandable that taxpayers expect further changes to tax brackets to be made in the coming years.

Some may downplay the impact of the TCJA rate expiration because the changes are only three to four percentage points. But for some brackets, this translates to a 25% increase in the taxes you pay. For example, the 12% tax bracket moves to 15% (for married couples filing jointly, this applies to incomes up to $89,450). That means your taxes would increase by more than $2,000 overnight alone. (And if you need more help planning for potential tax increases, consider talking to a financial advisor.)

Legacy planning

Ask an advisor: How can tax rates be higher in retirement than your earning years?Ask an advisor: How can tax rates be higher in retirement than your earning years?

Ask an advisor: How can tax rates be higher in retirement than your earning years?

When it comes to tax planning, we shouldn’t just consider the taxpayer’s lifespan. Pre-tax money passed on to heirs will still be subject to income taxes at some point in the future. If that inheritance occurs during the beneficiary’s peak earning years, it could result in a significant tax increase compared to what the original taxpayer would have paid even without any of the other factors applying.

Understanding what someone might pay in taxes now versus the future will have a major impact on whether specific tax planning strategies should be pursued. Any strategies that intentionally alter the timing of income, whether that’s accelerating income through Roth conversions or capital gains harvesting, or accelerating deductions through tax-efficient charitable giving, should be viewed through the lens of how tax rates in may change over time. While these strategies can create new financial flexibility for the future, they can lead to higher taxes in any given retirement year. (And if you need more help with your financial plan, consider consulting a financial advisor.)

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In short

The idea that taxes will go away for everyone in retirement is a common myth that unfortunately leads to inaction when it comes to tax planning. The best way to avoid skyrocketing taxes in retirement is to have a proactive and intentional plan tailored specifically to your individual situation. Tax planning is about consistent action over time, not a one-time major event. Small hinges will open big doors when it comes to lowering someone’s retirement tax bill.

Tips for finding a financial advisor

  • Finding a financial advisor does not have to be difficult. SmartAsset’s free tool matches you with up to three vetted financial advisors serving your area, and you can interview your advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • Consider a few advisors before choosing one. It’s important to make sure you find someone you trust to manage your money. As you consider your options, these are the questions you should ask an advisor to ensure you make the right choice.

Steven Jarvis, CPA, is a financial planning columnist at SmartAsset, answering reader questions about personal finance and tax topics. Do you have a question that you would like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.

Please note that Steven is not a participant in the SmartAdvisor Match platform and has received compensation for this article. The author’s taxpayer resources can be found at pensionetaxpodcast.com. Resources for the author’s financial advisors are available at pensionetaxservices.com.

Photo credit: ©iStock.com/gradyreese, ©iStock.com/kate_sept2004

The post Ask an Advisor: How Can Tax Rates Be Higher in Retirement than Your Earning Years? appeared first on SmartAsset Blog.

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