Key Takeaways:
- Your cheapest tax years are the ones right around your last day of work. Once the paycheck stops but before your benefits and required withdrawals begin, your income dips… and low income is what makes moves like a Roth conversion affordable.
- The balance in your 401(k) isn’t all yours. Money in a traditional account has never been taxed, so a portion of what you see on the statement belongs to the IRS. What you can actually spend is less than the number shown.
- Most expensive mistakes are timing mistakes. Severance, a stock sale, a Roth conversion, and a rollover can each be a fine idea on its own and still add up to a painful year when they all land together.
You retire in the spring. The paperwork clears, the first pension check lands, and for ten months everything looks exactly the way you planned it. Then April comes, and your accountant walks you through a tax bill far bigger than the one you budgeted for.
Nothing went wrong with your investments. The problem was timing… a handful of decisions made on the way out the door that nobody looked at together until the return was already due. Here are the four mistakes that cause most of those surprises, and how to sidestep each one.
Mistake 1: Treating Taxes as Something You Deal With in April
Your accountant’s job is to report what already happened. By the time your return is being prepared, every decision that shaped it is months behind you.
Planning, on the other hand, will help you evaluate when your retirement income should show up, which accounts it should come from, and what a move this year does to the next ten.
Mistake 2: Letting One Type of Account Hold Almost Everything
Your retirement savings probably sit in some mix of three account types. They’re taxed in completely different ways, which is why the type matters as much as the balance.
Traditional 401(k)s and individual retirement accounts (IRAs). You took a deduction when the money went in, so none of it has been taxed yet. Every dollar you pull out counts as ordinary income, at the same rates that applied to your paycheck.
Roth accounts. You already paid the tax on the way in. Qualified withdrawals come out completely tax-free and add nothing to your taxable income for the year.
Taxable brokerage accounts. You paid tax on this money before you invested it, so you only owe tax on the growth when you sell, usually at long-term capital gains rates that run lower than ordinary income rates.
If you keep almost everything in the first bucket, you’ll hand yourself a problem later, because every dollar you need has to come out as taxable income. There’s no lever to pull in a year when you’d rather keep your income down.
Why a Large Pre-Tax Balance Catches Up With You
The IRS doesn’t let that money sit untaxed forever. Starting at age 73, required minimum distributions (RMDs) force you to withdraw a set amount every year whether you need the cash or not.1 The amount is based on your balance and your age, so the bigger the account, the bigger the forced withdrawal.
That income lands on top of everything else you already have coming in. It can push you into a higher bracket, pull more of your Social Security onto your tax return, and raise your Medicare premiums, all from money you never asked to withdraw.
The fix isn’t equal balances in all three buckets. It’s having enough in each that you get to choose where a given year’s spending money comes from, instead of having exactly one option.
The Cheap Window Most People Sleep Through
Here’s the opening. Between your last paycheck and the start of Social Security, a pension, and required withdrawals, your taxable income can drop to its lowest point in decades. Low income means low tax brackets, and low brackets make certain moves unusually cheap.
A Roth conversion is the big one. You move money from a traditional account into a Roth and deliberately pay the income tax on it now, while your rate is low so that it can grow tax-free from there and never face a required withdrawal.
Size it carefully, though. The goal is usually to convert just enough to fill up your current tax bracket without spilling into the next one, which is why this is a year-by-year calculation rather than a one-time decision.
Two practical notes. Pay the tax with cash from outside the account when you can, since using the converted money shrinks the amount left to grow. And treat the decision as permanent, because you can’t undo a conversion once it’s done.
Mistake 3: Turning On Your Income in the Wrong Order
Every income source you have meets on the same tax return, and some of them change how the others get taxed. That makes the order you start them in a decision worth thinking through.
How Pensions and Social Security Are Actually Taxed
A pension funded with pre-tax dollars is the simple one. Just about every dollar you collect counts as ordinary income, taxed the same way your salary was.
Social Security is where people get tripped up, because it isn’t taxed at a flat rate and it isn’t automatically tax-free. How much of it gets taxed depends on how much other income you have that year. The IRS adds your other income to half your benefit, and as that total climbs past certain thresholds, more of your benefit gets pulled onto your return, up to 85% of it.3
So starting a pension can raise your tax bill twice over. The pension itself gets taxed, and it also lifts the income figure that decides how much of your Social Security is taxable: one decision, two separate effects.
Starting Benefits Is a One-Way Door
Social Security and pension income are different from every other decision on this list, because they’re permanent. Those checks arrive every year for the rest of your life, so the low-income window closes behind them and doesn’t reopen.
That’s the trade worth weighing. Waiting on Social Security gets you a larger monthly check, while claiming early hands you income now and gives up the flexible years you could have used for conversions or gains at a lower rate.
The Survivor Trap Married Couples Miss
This one catches almost everyone off guard. When one spouse dies, the household keeps the larger Social Security benefit and loses the smaller one. Say a couple collects $30,000 and $18,000 between them. The survivor drops to $30,000, so household income falls by about a third.
Their taxes can still go up. The survivor now files as a single taxpayer, and single brackets are narrower with a smaller standard deduction. Less income, taxed harder, while the property taxes, the insurance, and most of the household bills stay right where they were.
Modeling that scenario ahead of time is what turns it from a shock into a plan. It’s also one of the strongest arguments for building up Roth money while both spouses are alive.
Stacking Too Many Taxable Events Into One Year
Picture someone retiring in June. They collect six months of salary, a severance payment, and a payout for unused vacation. That fall, feeling good about the transition, they sell an appreciated stock position to fund a kitchen remodel and convert part of an IRA to Roth while they’re at it.
Every one of those moves was defensible on its own. Together, they can push the household into a much higher bracket, shrink a health insurance subsidy, and raise Medicare premiums two years down the road.
Before you pull the trigger on any big taxable transaction, take stock of what’s already on the return that year:
- Final salary, bonuses, severance, unused leave, deferred compensation, and equity awards, which can make your retirement year unusually heavy.
- Sales of appreciated investments, which raise your income and can change how those gains get taxed.
- A large withdrawal from a traditional IRA or 401(k), every dollar of which counts as ordinary income.
- A Roth conversion, which piles taxable income on top of all of it.
Spreading those events across two or three years often costs far less than doing them all at once, and you rarely have to give up any of the moves you wanted to make. You’re just changing when they happen.
Please Note: Your income affects healthcare costs on both sides of age 65. Before Medicare, Marketplace premium tax credits get reconciled against your household income for the year,4 and after you enroll, Medicare sets any income-related surcharge using your modified adjusted gross income (MAGI) and filing status from a return two years earlier.5
Mistake 4: Botching the Rollover Paperwork
A solid long-term plan can still cost you serious money if the paperwork goes wrong on the way out of an employer plan. What matters most is whether the check gets written to you or sent straight to the receiving account.
Ask for a direct rollover, where the plan sends your money straight to the new custodian, and nothing is withheld. Have the money paid to you instead, and the plan must withhold 20% for taxes, even when you fully intend to roll it over.6
Here’s why that stings. On a $200,000 balance, they’d send you $160,000 and hold back $40,000. To complete a full rollover, you have to deposit the entire $200,000 within 60 days, which means finding that missing $40,000 somewhere else. Come up short, and the difference counts as a taxable withdrawal for the year.
Two things deserve a look before you move an entire balance. If you have an outstanding loan against the plan, the offset may qualify for a longer rollover deadline than the usual 60 days.7 And if you hold appreciated company stock in the plan, special treatment called net unrealized appreciation (NUA) can sometimes tax the growth at lower capital gains rates instead of ordinary income.8 The conditions are narrow, so handle it before the balance moves.
One last thing catches people off guard. Payroll withholding ends with your final paycheck, but your obligation to pay tax throughout the year doesn’t. Pensions, withdrawals, investment income, and taxable Social Security may all need new withholding elections or quarterly estimated payments, and paying too little along the way can trigger a penalty even if you settle up in full come April.9
Tax Mistakes Pre-Retirees Make FAQs
1. How many years before retirement should tax planning start?
Three to five years out is a reasonable place to start, with a fresh look every year after that. Wait until you’ve already retired, and most of the useful adjustments are behind you.
2. Is putting everything in a traditional 401(k) a mistake?
Not necessarily, since the deduction is genuinely valuable while you’re earning well; the concern is concentration, because a large pre-tax balance eventually forces taxable withdrawals you may not want or need.
3. When do Roth conversions make sense?
Usually when your taxable income dips below where you expect it to settle later, which for most people is the stretch right after they stop working. Keep in mind that a conversion is permanent, so most people do smaller amounts over several years.
4. How much of my Social Security will be taxed?
It depends entirely on your other income that year, and it can range from none of it to 85% of it. Pension payments, retirement account withdrawals, and investment gains all push that number higher.
5. Can a big gain or conversion raise my healthcare costs?
Yes, on both sides of 65. That’s why healthcare costs belong inside the tax projection rather than being treated as a separate line in the budget.
6. What should I check before rolling over a 401(k)?
Whether the transfer is direct, whether any withholding applies, and whether after-tax contributions, an outstanding plan loan, or company stock need special handling, confirm where the money is going before you request anything.
Build a More Tax-Aware Retirement Transition
Notice what these four mistakes have in common. Not one of them involves picking the wrong investment. They come down to timing, sequence, and paperwork, which means they’re largely preventable with some foresight.
Our team can project what your taxable income looks like in the years ahead, review how your savings are split across the three account types, identify which conversion windows are worth using, and map out when your pension, Social Security, and withdrawals should each begin.
We can also walk you through rollover mechanics, company stock, withholding, estimated payments, and the healthcare thresholds that surprise people. To put a coordinated plan behind these decisions, schedule a complimentary consultation with our team.
Resources:
1) IRS Retirement Topics: Required Minimum Distributions
2) IRS Publication 590-A (Contributions to Individual Retirement Arrangements)
3) IRS Publication 915 (Social Security and Equivalent Railroad Retirement Benefits)
4) IRS Publication 974 (Premium Tax Credit)
5) Social Security: Medicare Premiums
6) IRS Topic No. 413 (Rollovers From Retirement Plans)
