The complexity of the U.S. tax code has become a significant challenge for many retirees. According to Intuit, the U.S. tax code now exceeds 6,000 pages, encompassing statutes, regulations, and IRS guidance. A survey conducted by the Tax Foundation found that 66% of Americans believe the tax code is overly complicated, and as a result, many retirees face significant challenges in managing their finances, especially when their income sources are varied, such as Social Security, dividends, interest, and capital gains.
Without guidance from an experienced financial professional, many retirees miss out on valuable strategies that could lower their tax burden, leading to unnecessary tax expenses. This is particularly true for those relying heavily on traditional retirement accounts (such as IRAs and 401(k)s), as these accounts can trigger substantial tax liabilities. The following are the top three tax mistakes that U.S. retirees commonly make, and each one could cost you thousands if not addressed properly.
Long-term capital gains tax and qualified dividend tax rates are generally more favorable than ordinary income tax rates. According to the tax laws for 2025, individuals with taxable income up to $48,350 are taxed at a 0% long-term capital gains rate, and married couples filing jointly are taxed at the same rate if their taxable income is under $96,700. These generous tax brackets provide retirees with a unique opportunity to realize gains—such as selling appreciated assets in taxable brokerage accounts—without triggering significant tax liabilities.
However, many retirees overlook this opportunity, particularly those who have most of their wealth stored in traditional IRAs. Traditional IRA funds are subject to Required Minimum Distributions (RMDs) starting at age 73, which can lead to a significant tax burden. If retirees do not take advantage of the favorable capital gains rates, they could miss the chance to minimize their taxes. By strategically repositioning assets into more tax-efficient investments, retirees may save a substantial amount in taxes.
In addition to this, the taxation of Social Security benefits is another area where retirees often make costly mistakes. While Social Security benefits themselves are not taxed like ordinary income, the IRS uses your “provisional income” to determine the taxability of those benefits. Provisional income includes half of your Social Security benefits, plus other income sources such as wages, dividends, and tax-free interest.
If a retiree’s provisional income exceeds certain thresholds, up to 85% of their Social Security benefits could become taxable. For example, single filers whose income exceeds $34,000, or married couples filing jointly whose income exceeds $44,000, could see up to 85% of their Social Security benefits taxed. Even small increases in income can push a retiree into a higher tax bracket, resulting in a sudden spike in taxes on their Social Security benefits, a phenomenon often referred to as the "tax torpedo."
This sudden tax spike is one of the most common tax mistakes retirees make. To avoid this costly mistake, it is crucial to carefully plan across all income sources and retirement withdrawals. In the early years of retirement—especially before starting to claim Social Security—retirees should consider creating a comprehensive financial plan to avoid the additional tax burden caused by even modest increases in income.
Among the various tax strategies, Roth IRA conversions are particularly popular. A Roth IRA allows retirees to take tax-free distributions, which is an appealing option for those seeking to reduce their tax burden during retirement. A Roth IRA conversion involves transferring funds from a traditional IRA or 401(k) into a Roth IRA. However, many retirees mismanage Roth conversions due to poor timing or converting too much or too little.
Consider the example of Michelle, a 55-year-old retiree with $2 million in traditional retirement accounts. She plans to gradually convert her traditional IRA to a Roth IRA. If she converts too much too soon while still working, she could push herself into a higher tax bracket. On the other hand, if she waits too long, the Required Minimum Distributions (RMDs) starting at age 73 could force her into a higher tax bracket in the future.
The ideal time for larger Roth IRA conversions is often between retirement at age 62 and claiming Social Security at age 70. During this period, retirees typically have a lower income, and the tax bracket is generally more favorable, making it an optimal time to perform conversions. By doing so, retirees can significantly reduce their lifetime tax burden.
That said, Roth IRA conversions require careful planning. Retirees should assess their specific financial circumstances and future income projections before making any large conversions. A financial professional can help retirees model their tax outlook and optimize their Roth IRA conversion strategy for the long term.
Overall, tax planning is crucial for retirees, and many people assume that with lower retirement income, their tax burden will naturally decrease. In reality, however, poor tax decisions can lead to significant financial losses.
By planning strategically, utilizing tax-efficient strategies, and avoiding common pitfalls such as the Social Security tax torpedo or inefficient Roth conversions, retirees can effectively reduce their tax liabilities and ensure a more secure financial future.