10 Tax Surprises That Can Derail Your Retirement if You Don't Plan Ahead

A comfortable retirement is the primary financial goal for many taxpayers. It’s also one that’s difficult to attain. According to Bloomberg, less than a quarter of American workers think they’ll have enough saved up to maintain a good standard of living when they hit retirement age. 

Of course, if you make smart money moves, you might be able to retire early. But even in retirement, you won’t be saying goodbye to Uncle Sam. The IRS still wants a piece of your financial pie.

Here are the 10 biggest tax surprises you could face in retirement.

Although 401(k) contributions lower your taxable income because they get taken out of your paycheck before taxes, the downside is that distributions from your 401(k) are still taxed as income, even if you’re retired.

The same goes for traditional IRAs. As soon as your IRA becomes income, anything you take out can be taxed. The IRS covers what taxes you can expect on withdrawals online in Publication 590.

If you bought an annuity and it’s paying out in your retirement, any earnings beyond your original investment get taxed as regular income.

The situation is a little different if you bought the annuity through a traditional IRA with pre-tax money. Instead, the whole payment will be taxed as income.

Making your money work for you by investing while you’re employed is a stellar idea. However, that doesn’t mean you can dodge taxes on those investments after you retire.

Depending on your income, most long-term capital gains aren’t taxed any higher than 15% or 20%. That rate can even be as low as 0% or max out at 28%.

Stocks, bonds, mutual funds, and qualified dividends are generally taxed at the same long-term capital gains rates of 0%, 15%, or 20%. Diversifying those investments can be a good way to use your tax refund.

Giving gifts can help knock down looming estate taxes. The max annual gift amount for tax year 2024 is $18,000. For 2025, it’s $19,000. 

Going further, the basic exclusion amount is $13,610,000 for 2024 and $13,990,000 for 2025.

Here’s the rub: Those amounts still face gift taxes. Moreover, anything that can be applied to the exclusion also lowers estate tax exemptions. And some states tax inheritances too.

The money you get as the beneficiary of someone’s life insurance plan isn’t usually taxable. It doesn’t get counted as income, and you don’t have to report it. That doesn’t change if you’re retired.

The interest you receive is taxable, however. And the situation becomes more complex if you’re the policyholder and surrender it for cash, particularly if you get more back than the cost of the policy. 

Any retirement payments you get from a pension or annuity are taxable unless they’re from a Roth plan. They’re fully taxable if you didn’t put any after-tax money into them, your employer didn't withhold after-tax contributions from your salary, or you got your after-tax contributions tax-free earlier.

If you put after-tax money into a pension or annuity, it’s partially taxable, but taxes on the payments vary depending on what you contributed.

Property taxes aren’t something you have direct control over, unlike a lot of other aspects of retirement preparation. But chances are, if you own a home, they’ll go up. 

The average cost of a home in the U.S. was over $400,000 in 2024. That might be great news if you’re looking to sell. It’s significantly less than great news if you’re a retiree with no interest in selling your home because it means rising property taxes will continue to siphon away your money.

If you were thinking to yourself, “Well, I’ll simply not withdraw any retirement savings and avoid potential taxes,” then we have some bad news. You are required to start taking annual withdrawals from your retirement accounts when you hit 72.

The minimum amount is calculated based on the year-end account balance of the immediately preceding calendar year divided by a distribution period from the IRS’s “Uniform Lifetime Table.”

You can take out more, of course, but any amount withdrawn has to be included in your taxable income when you file your return. 

This might be a shock but you have to pay taxes on Social Security benefits. How much depends on your benefits and your and your spouse’s retirement income.

Broadly speaking, half of the amount you get in benefits is taxable. That can jump up to 85% if half your benefits plus all other income tops more than $34,000 (or $44,000 for those married filing jointly) or you file separately from your spouse but lived together at any time.

The good news is that 85% is the max amount the IRS can tax.

It’s not all bad news. Retirees and older taxpayers have some options when it comes to lowering their tax bills.

For starters, if you and/or your spouse are 65 and older, you get a higher deduction. That deduction goes up more if or either of you is blind. 

There’s also a tax credit (between $3,750 and $7,500) for the elderly or the disabled, though there are stipulations about who qualifies. And if you’re self-employed in retirement, premium expenses for Medicare Part B and Medicare Part D can be deducted.

There’s no way around it: Uncle Sam wants a bite of your retirement savings. Even death doesn’t really stop the IRS, as Roth IRA beneficiaries are subject to required minimum distribution rules.

At least there are ways to ease your tax burden in retirement. One is to diversify. Take a little from a taxable source and a little from a nontaxable source. That can help keep your taxable income lower. 

As always, hiring a tax professional is going to be the easiest way to deal with the taxes you face in retirement. But if you decide to do it yourself, be sure to understand all the facts so you can prepare yourself financially.