Retirement Tax Traps and Penalties: 5 Gotchas That Catch People Off Guard

Even the most disciplined savers can be blindsided in retirement by unexpected taxes, penalties, and benefit reductions that derail a carefully built plan. These “retirement gotchas” often appear subtle during your working years but can cost tens of thousands once you stop earning a paycheck.

Here are five of the biggest surprises retirees face—and how to avoid them before it’s too late.

1. The Tax Torpedo from Social Security

Many retirees are surprised to learn that Social Security isn’t always tax-free. Depending on your income, up to 85% of your benefit can be taxed.

The IRS uses something called “provisional income,” which includes half your Social Security benefit plus all other taxable income and tax-free municipal bond interest.

• For individuals, taxes begin when provisional income exceeds $25,000.

• For married couples, it starts at $32,000.

A well-intentioned IRA withdrawal or capital gain can push you over these thresholds—causing a sudden jump in taxes. Strategic Roth conversions and careful withdrawal sequencing can help smooth this out over time.

2. Higher Medicare Premiums (IRMAA)

The Income-Related Monthly Adjustment Amount (IRMAA) is one of the most overlooked retirement costs. Once your modified adjusted gross income (MAGI) exceeds certain limits, your Medicare Part B and D premiums increase—often by thousands of dollars per year.

For 2025, IRMAA surcharges begin when MAGI exceeds roughly $103,000 for single filers or $206,000 for married couples. The catch? Medicare looks back two years at your income. A Roth conversion, property sale, or large one-time distribution can unexpectedly trigger higher premiums two years later.

Proactive tax planning can prevent crossing these thresholds unintentionally.

3. Required Minimum Distributions (RMDs)

Once you reach age 73, the IRS requires you to start withdrawing from pre-tax retirement accounts each year—whether you need the money or not. These RMDs are taxed as ordinary income and can increase your tax bracket, raise Medicare premiums, and reduce your eligibility for certain deductions.

The biggest mistake is waiting until your 70s to plan for them. Roth conversions in your 60s can reduce future RMDs, and charitable giving through Qualified Charitable Distributions (QCDs) can offset the tax impact once they begin.

4. The Widow’s Penalty

When one spouse passes away, the surviving spouse’s tax brackets and standard deduction are cut in half—but income sources often don’t decrease proportionally. Social Security may drop by one benefit, but RMDs, pensions, and investment income remain largely the same.

The result is a higher effective tax rate for the survivor. This “widow’s penalty” can last for years, especially when combined with RMDs and Medicare surcharges. Couples can reduce the long-term impact through lifetime Roth conversions, strategic asset titling, and beneficiary planning.

5. State Taxes and Hidden Relocation Costs

Many retirees move to lower-tax states hoping to stretch their income, but state-level taxes can be tricky. Some states tax pension and IRA withdrawals, others tax Social Security, and a few impose taxes on out-of-state income or estates.

Additionally, higher property taxes, insurance premiums, and healthcare costs can offset income tax savings. A comprehensive cost-of-living comparison is essential before relocating.

Our analysis at Greenbush Financial Group often reveals that the “best” retirement state depends more on quality of life, healthcare access and total cost of living than on income tax rates alone.

How to Avoid These Retirement Surprises

Most retirement gotchas come down to timing and coordination—especially between taxes, Social Security, and healthcare. A few key steps can make a major difference:

• Run retirement income projections that include taxes and IRMAA thresholds.

• Consider partial Roth conversions before RMD age.

• Sequence withdrawals intentionally between taxable, tax-deferred, and Roth accounts.

• Evaluate the long-term impact of home state taxes before moving.

• Review beneficiary and trust structures regularly.

The earlier you identify potential traps, the easier they are to fix while you still control your income and withdrawals.

The Bottom Line

Retirement is more complex than simply replacing a paycheck. The interplay between taxes, healthcare, and income sources can turn small decisions into costly mistakes. By spotting these gotchas early, you can preserve more of your wealth and enjoy a smoother, more predictable retirement.

Our advisors at Greenbush Financial Group can help you identify your biggest risk areas and design a plan to minimize the tax and income surprises most retirees never see coming.

FAQs: Retirement Planning Surprises

Q: Are Social Security benefits always taxed?
A: No. But depending on your income, up to 85% of your benefits may be taxable.

Q: How can I avoid higher Medicare premiums?
A: Manage your income below IRMAA thresholds through strategic Roth conversions and tax-efficient withdrawals.

Q: What happens if I miss an RMD?
A: You could face a 25% penalty on the amount not withdrawn, reduced to 10% if corrected quickly.

Q: Why do widows and widowers pay more in taxes?
A: Filing status changes from joint to single, cutting brackets and deductions in half while much of the income remains.

Q: Are all retirement states tax-friendly?
A: No. Some states tax retirement income or have higher overall costs despite no income tax.

Rob Mangold

About Rob……...

Hi, I’m Rob Mangold. I’m the Chief Operating Officer at Greenbush Financial Group and a contributor to the Money Smart Board blog. We created the blog to provide strategies that will help our readers personally, professionally, and financially. Our blog is meant to be a resource. If there are questions that you need answered, please feel free to join in on the discussion or contact me directly.

How to Maximize Social Security Benefits with Smart Claiming and Income Planning

By Michael Ruger, CFP®
Partner and Chief Investment Officer at Greenbush Financial Group

For many retirees, Social Security is a cornerstone of their retirement income. But when and how you claim your benefits—and how you plan your income around them—can have a major impact on the total amount you receive over your lifetime. With updated Social Security thresholds, limits, and rules, there are new opportunities to optimize your claiming strategy and coordinate Social Security with your broader financial plan.

In this article, we’ll cover:

• How Social Security benefits are calculated and funded

• Four ways to increase your Social Security benefit amount

• How income and taxes affect your benefits

• The impact of Medicare premiums and income planning

• How delaying Social Security can create opportunities for Roth conversions

• What to know about the earned income penalty if you claim early

• Answers to common Social Security claiming questions

Maximizing Social Security During the Working Years

The foundation for a strong Social Security benefit starts during your working years. Understanding how the system works helps you make informed decisions about your career, income, and retirement planning.

How Social Security Is Funded and Calculated

Social Security is primarily funded through payroll taxes under the Federal Insurance Contributions Act (FICA). In 2025, workers and employers each pay 6.2% of wages (for a total of 12.4%) up to the taxable wage base, which is $176,000 in 2025. Any earnings above that amount are not subject to Social Security tax and do not increase your benefit.

Your benefit is based on your highest 35 years of indexed earnings—meaning each year’s income is adjusted for inflation to reflect its value in today’s dollars. If you worked fewer than 35 years, zeros are included in the calculation, which can significantly reduce your average and therefore your monthly benefit.

Key takeaway: Once your annual income exceeds the taxable wage base, additional earnings don’t raise your future Social Security benefit. However, working longer can still increase your benefit if you replace lower-earning years or zeros in your 35-year average.

Four Ways to Increase Your Social Security Benefits

1. Fill in or Replace Zero Years

If you have fewer than 35 years of work history, each missing year is counted as zero. Even one extra year of income can replace a zero and raise your benefit.

Example: If you worked 32 years and earned $80,000 annually in your final three years, adding those years could significantly boost your benefit calculation.

2. Delay Claiming to Earn Higher Benefits

You can claim Social Security as early as age 62, but doing so permanently reduces your benefit—up to 30% less than your full retirement age (FRA) amount. For those born in 1960 or later, FRA is 67.

If you wait past FRA, your benefit grows by 8% per year up to age 70, plus annual cost-of-living adjustments (COLAs).

Example:

• Claiming at 62: $1,400/month

• Claiming at 67: $2,000/month

• Claiming at 70: $2,480/month

That’s a $1,080 per month difference for waiting between the ages of 62 and 70.

3. Maximize Spousal and Dependent Benefits

Spousal and dependent benefits can be valuable for married couples or retirees with young children.

• Spousal Benefit: A spouse can claim up to 50% of the higher earner’s FRA benefit, provided the higher earner has already filed.

• Divorced Spouse Benefit: You may qualify if the marriage lasted 10 years or longer, and you haven’t remarried prior to age 60.

• Dependent Benefit: Retirees age 62+ with children under 18 may receive additional benefits for dependents.

Planning tip: For individuals who plan to utilize the 50% spousal benefit and/or the dependent benefit, the path to the optimal filing strategy is more complex because the spouse and dependents cannot receive these benefits until that individual has actually turned on their social security benefit, which, in some cases, can favor not waiting until age 70 to file.

4. Understand Survivor Benefits

If one spouse passes away, the surviving spouse receives the higher of the two benefits. This makes it especially beneficial for the higher-earning spouse to delay claiming to age 70, maximizing the survivor benefit and providing long-term income protection.

How Social Security Benefits Are Taxed

Up to 85% of your Social Security benefits may be taxable, depending on your combined income (adjusted gross income + nontaxable interest + half of your Social Security benefits).

• Single filers: Taxes begin at $25,000 of combined income

• Married filing jointly: Taxes begin at $32,000 of combined income

If you don’t need Social Security to cover living expenses right away, delaying benefits can not only increase your future income but may also help manage taxes by controlling your income levels in early retirement.

Medicare Premiums and Income Planning

Once you reach age 65, you’ll typically enroll in Medicare Part B and D, and your premiums are based on your Modified Adjusted Gross Income (MAGI). Higher income means higher premiums under the Income-Related Monthly Adjustment Amount (IRMAA) rules.

Because Social Security benefits count as income for these purposes, timing your claiming strategy can help you manage Medicare costs.

Roth Conversions: Turning Delay into an Opportunity

Delaying Social Security creates a window for Roth conversions—moving money from a traditional IRA to a Roth IRA at potentially lower tax rates before Required Minimum Distributions (RMDs) begin at age 73 or 75.

Benefits of Roth conversions include:

• Paying tax now at potentially lower rates

• Reducing future RMDs

• Potentially reduce future Medicare premiums

• Creating a tax-free income source in retirement

• Leaving tax-free assets to heirs

Coordinating your claiming strategy with Roth conversions can improve long-term tax efficiency and enhance your retirement flexibility.

Claiming Early? Know the Earned Income Penalty

If you claim Social Security before full retirement age and continue to work, your benefits may be temporarily reduced.
In 2025, the earnings limit is $23,400. For every $2 earned over the limit, $1 in benefits is withheld.

In the year you reach FRA, a higher limit applies: $62,160, and only $1 is withheld for every $3 earned above that.
Once you reach full retirement age, the penalty disappears, and your benefit is recalculated to credit any withheld amounts.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQ)

How are Social Security benefits calculated?
Social Security benefits are based on your highest 35 years of indexed earnings, adjusted for inflation. If you worked fewer than 35 years, zeros are included in your calculation, which can reduce your benefit.

What are the main ways to increase your Social Security benefits?
You can boost your benefit by replacing “zero” earning years, delaying your claim up to age 70 for an 8% annual increase past full retirement age, and coordinating spousal or survivor benefits strategically. Working longer and earning more during high-income years can also improve your benefit calculation.

How does delaying Social Security affect taxes and Medicare premiums?
Delaying benefits can help you manage taxable income in early retirement and avoid higher Medicare premiums triggered by the IRMAA income thresholds. This window can also allow for Roth conversions, which reduce future Required Minimum Distributions (RMDs) and create tax-free income in later years.

How are Social Security benefits taxed?
Up to 85% of your benefits may be taxable depending on your combined income (adjusted gross income + nontaxable interest + half of your benefits). Taxes begin at $25,000 for single filers and $32,000 for married couples filing jointly. Managing income sources can help minimize these taxes.

What is the earned income penalty for claiming Social Security early?
If you claim before full retirement age and continue working, benefits are reduced by $1 for every $2 earned above $23,400 in 2025. In the year you reach full retirement age, the limit increases to $62,160, and only $1 is withheld for every $3 earned over that amount. The penalty ends at full retirement age, when your benefit is recalculated.

What are spousal and survivor Social Security benefits?
A spouse can claim up to 50% of the higher earner’s full retirement benefit once that person has filed. If one spouse passes away, the survivor receives the higher of the two benefits. This makes it especially advantageous for the higher earner to delay claiming to age 70 to maximize long-term income protection.

How can Roth conversions complement Social Security planning?
Performing Roth conversions in the years before claiming Social Security or reaching RMD age allows retirees to shift pre-tax funds into tax-free accounts at potentially lower tax rates. This strategy can reduce future taxable income, manage Medicare premiums, and increase retirement flexibility.

Multi-Generational Roth Conversion Planning

With the new 10-Year Rule in place for non-spouse beneficiaries of retirement accounts, one of the new tax strategies for passing tax-free wealth to the next generation is something called the “Next Gen Roth Conversion Strategy”.  This tax strategy works extremely well when the beneficiaries of the retirement account are expected to be in the same or higher tax bracket than the current owner of the retirement account.  

Here's how the strategy works. The current owner of the retirement account begins to initiate large Roth conversions over the course of a number of years to purposefully have those pre-tax retirement dollars taxed in a low to medium tax bracket. This way, when it comes time to pass assets to their beneficiaries, the beneficiaries inherit Roth IRA assets instead of pre-tax Traditional IRA and 401(k) assets that could be taxed at a much higher rate due to the requirement to fully liquidate and pay tax on those assets within a 10-year period.  

In addition to lowering the total income tax paid on those pre-tax retirement assets, this strategy can also create multi-generational tax-free wealth, reduce the size of an estate to save on estate taxes, and reduce future RMDs for the current account owner.

10-Year Rule for Non-Spouse Beneficiaries

This tax strategy surfaced when the new 10-Year Rule went into place with the passing of the Secure Act.  Non-spouse beneficiaries who inherit pre-tax retirement accounts are now required to fully deplete and pay tax on those account balances within a 10-year period following the passing of the original account owner.  In many cases when children inherit pre-tax retirement accounts from their parents, they are still working, which means that they already have income on the table. 

For example, if Josh, a non-spouse beneficiary, inherits a $600,000 Traditional IRA from his father when he is age 50, he would be required to pay tax on the full $600,000 within 10 years of his father passing. But what if Josh is married and he and his wife still work and are making $360,000 per year?  If Josh and his wife do not plan to retire within the next 10 years, the $600,000 that is required to be distributed from that inherited IRA while they are still working could be subject to very high tax rates since the taxable distribution stacks on top of the $360,000 that they are already making.  A large portion of those IRA distributions could be subject to the 32% federal tax bracket.

If Josh’s father had started making $100,000 Roth conversions each year while both he and Josh’s mother were still alive, they could have taken advantage of the 22% Federal Tax Bracket I in 2025 (which ranges from $96,951 to $206,000 in taxable income). If they had very little other income in retirement, they could have processed large Roth conversions, paid just 22% in federal taxes on the converted amount, and eventually passed a Roth IRA on to Josh. Utilizing this strategy, the full $600,000 pre-tax IRA would have been subject to the parent’s federal tax rate of 22% as opposed to Josh’s tax rate of 32%, saving approximately $60,000 in taxes paid to the IRS.

Tax Free Accumulations For 10 More Years

But it gets better.  By Josh’s parents processing Roth conversions while they were still alive, not only is there multigenerational tax savings, but when John inherits a Roth IRA instead of a Traditional IRA from his parents, all of the accumulation within that Roth IRA since the parents completed the conversion, PLUS 10 years after Josh inherits the Roth IRA, are completely tax-free. 

Multi-generational Tax-Free Wealth

If you are a non-spouse beneficiary, whether you inherited a pre-tax retirement account or a Roth IRA, you are subject to the 10-year distribution rule (unless you qualify for one of the exceptions). With a pre-tax IRA or 401(k), not only is the beneficiary required to deplete and pay tax on the account within 10 years, but they may also be required to process RMDs (required minimum distributions) from their inherited IRA each year, depending on the age of the decedent when they passed away.

With an Inherited Roth IRA, the account must be depleted in 10 years, but there is no annual RMD requirement, because RMDs do not apply to Roth IRAs subject to the 10-year rule.  So, essentially, someone could inherit a $500,000 Roth IRA, take no money out for 9 years, and then at the end of the 10th year, distribute the full balance TAX-FREE.  If the owner of the inherited Roth IRA invests the account wisely and obtains an 8% annualized rate of return, at the end of year 10 the account would be worth $1,079,462, which would be withdrawn completely tax-free.

Reduce The Size of an Estate

For individuals who are expected to have an estate large enough to trigger estate tax at the federal and/or state level, this “Next Gen Roth Conversion” strategy can also help to reduce the size of the estate subject to estate tax.  When a Roth conversion is processed, it’s a taxable event, and any tax paid by the account owner essentially shrinks the size of the estate subject to taxation. 

If someone has a $15 million estate, and included in that estate is a $5 million balance in a Traditional IRA and that person does nothing, it creates two problems.  First, the balance in the Traditional IRA will continue to grow, increasing the estate tax liability that will be due when the individual passes assets to the next generation.  Second, if there are only two beneficiaries of the estate, each beneficiary will have to move $2.5 million into their own inherited IRA and fully deplete and pay tax on that $2.5M PLUS earnings within a 10-year period.  Not great.

If, instead, that individual begins processing Roth conversions of $500,000 per year, and over a course of 10 years can fully convert the Traditional IRA to a Roth IRA (ignoring earnings), two good things can happen. First, if that individual pays an effective tax rate of 30% on the conversions, it will decrease the size of the estate by $1.5 million ($5M x 30%), potentially lowering the estate tax liability when assets are passed to the beneficiaries of the estate. Second, even though the beneficiaries of the estate would inherit a $3.5M Roth IRA instead of a $5M Traditional IRA, no RMDs would be required each year, the beneficiaries could invest the Inherited Roth IRA which could potentially double the value of the Inherited Roth IRA during that 10-year period, and withdraw the full balance at the end of year 10, completely tax free, resulting in big multi-generational tax free wealth.

The Power of Tax-Free Compounding

Not only does the beneficiary of the Roth IRA benefit from tax-free growth for the 10 years following the account owner's death, but they also receive the benefit of tax-free growth and withdrawal within the Roth IRA, as long as the account owner is still alive.  For example, if someone begins these Roth conversions at age 70 and they live until age 90, that’s 20 years of compounding, PLUS another 10 years after they pass away, so 30 years in total.

A quick example showing the power of this tax-free compounding effect: someone processes a $200,000 Roth conversion at age 70, lives until age 90, and achieves an 8% per year rate of return. When they pass away at age 90, the balance in their Roth IRA would be $932,191.  The non-spouse beneficiary then inherits the Roth IRA and invests the account, also achieving an 8% annual rate of return. In year 10, the Inherited Roth IRA would have a balance of $2,012,531. So, the original owner of the Traditional IRA paid tax on $200,000 when the Roth conversion took place, but it created a potential $2M tax-free asset for the beneficiaries of that Roth IRA.  

Reduce Future RMDs of Roth IRA Account Owner

Outside of creating the multi-generational tax-free wealth, by processing Roth conversions in retirement, it’s shifting money from pre-tax retirement accounts subject to annual RMDs into a Roth IRA that does not require RMDs.  First, this lowers the amount of future taxable RMDs to the Roth IRA account owner because assets are being shifted from their Traditional IRA to Roth IRA, and second, since RMDs are not required from Roth IRAs, the assets in that IRA are allowed to continue to compound investment returns without disruption. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Frequently Asked Questions (FAQs):

What is the “Next Gen Roth Conversion Strategy”?
The Next Gen Roth Conversion Strategy involves gradually converting pre-tax retirement assets, such as Traditional IRAs or 401(k)s, into Roth IRAs while the account owner is in a lower tax bracket. This allows heirs to inherit Roth assets that grow and distribute tax-free rather than being forced to pay higher taxes under the 10-Year Rule for inherited pre-tax accounts.

How does the 10-Year Rule affect inherited retirement accounts?
Under the SECURE Act, non-spouse beneficiaries must fully deplete inherited pre-tax retirement accounts within 10 years of the original owner’s death. This often forces distributions during high-income years, which can push beneficiaries into higher tax brackets and increase total taxes owed.

Why is this strategy beneficial for high-earning heirs?
When heirs are in the same or higher tax bracket as the original account owner, converting to a Roth during the parent’s lifetime allows the taxes to be paid at a lower rate. The heirs then inherit a Roth IRA that continues to grow tax-free and can be withdrawn without triggering additional income tax.

How does the strategy create multi-generational tax-free wealth?
After the account owner passes, heirs can keep the inherited Roth IRA invested for up to 10 years without required minimum distributions (RMDs). All investment growth during that time is tax-free, and the full balance can be withdrawn at the end of year 10 with no taxes owed.

Can Roth conversions also reduce estate taxes?
Yes. The taxes paid during the conversion process reduce the overall size of the estate, which may lower exposure to federal or state estate taxes. Converting pre-tax assets to Roth IRAs can therefore benefit both the heirs and the estate itself.

How does this strategy help minimize future RMDs?
By converting pre-tax accounts to Roth IRAs, retirees reduce the balance of assets subject to required minimum distributions. Since Roth IRAs do not require RMDs during the owner’s lifetime, more assets can continue compounding tax-free for longer.

What makes the Next Gen Roth Conversion Strategy so powerful?
It combines proactive tax planning, estate reduction, and multi-generational wealth transfer. Taxes are paid strategically at lower rates, future RMDs are minimized, and beneficiaries receive assets that can grow for up to a decade after inheritance—completely tax-free.

Roth Conversions In Retirement

Roth conversions in retirement are becoming a very popular tax strategy.  It can help you to realize income at a lower tax rate, reduce your RMD’s, accumulate assets tax free, and pass Roth money onto your beneficiaries.   However, there are pros and cons that you need to be aware of, because processing a Roth conversion involves showing more taxable income in a given year. Without proper tax planning, it could lead to unintended financial consequences such as:

·         Social Security taxed at a higher rate

·         Higher Medicare premiums

·         Assets lost to a long term care event

·         Higher taxes on long term capital gains

·         Losing tax deductions and credits

·         Higher property taxes

·         Unexpected big tax liability

In this video, Michael Ruger will walk you through some of the strategies that he uses with his clients when implementing Roth Conversions. This can be a very effective wealth building strategy when used correctly.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.