How Social Security and RMDs Can Unexpectedly Increase Your Tax Bill

Many retirees are surprised to learn that earning more income in retirement can sometimes result in a disproportionately higher tax bill. This phenomenon is often referred to as the “tax torpedo”, and it commonly occurs when Social Security benefits and required minimum distributions (RMDs) intersect in ways people don’t anticipate.

At the center of this issue is how Social Security benefits are taxed. Whether or how much of your Social Security is taxable depends on your combined income, which is calculated as:

• Adjusted Gross Income (AGI)
• nontaxable interest
• 50% of Social Security benefits

Based on this combined income, up to 85% of your Social Security benefits may become taxable. For individuals, taxation begins once combined income exceeds $25,000 and increases further above $34,000. For married couples filing jointly, the thresholds are $32,000 and $44,000. These limits are not indexed for inflation, which means more retirees are affected each year.

The “tax torpedo” often accelerates once RMDs begin, typically at age 73. RMDs from traditional IRAs and 401(k)s are taxed as ordinary income and directly increase your adjusted gross income. That additional income doesn’t just create more taxable dollars; it can also cause a larger portion of your Social Security benefits to become taxable at the same time. The result is an effective marginal tax rate that is much higher than expected.

For example, a retiree taking an extra dollar from an IRA may find that not only is that dollar taxed, but it also causes additional Social Security income to become taxable. This compounding effect is the essence of the tax torpedo, and it can push retirees into higher tax brackets without realizing why.

Understanding this dynamic is critical for effective retirement planning. Strategies such as smoothing income, partial Roth conversions before RMD age, or carefully coordinating withdrawals from taxable, tax-deferred, and tax-free accounts can help reduce the impact. Timing matters, and proactive planning can often soften or even avoid the sharp increase in taxes.

The key takeaway is that retirement taxes are not just about tax brackets. They’re about how different income sources interact. Without coordinated planning, retirees may unintentionally trigger higher taxes and reduce the longevity of their savings.

A thoughtful, forward-looking strategy can help keep more of your retirement income working for you, rather than being lost to unexpected tax consequences. Let’s discuss your strategy at your next appointment, so we can help you anticipate these potential issues.