If you have millions saved in your 401(k) and IRA, that feels like a win, and it is. But there’s one way a large balance quietly works against you: The more money sitting in tax-deferred accounts, the more likely the IRS is to tax the maximum allowable portion of your Social Security check.
That happens by default, unless you plan around it.
Most people who reach this point spent decades doing everything right: Saving consistently, maxing out their 401(k), following the advice they were given. That advice was built for accumulation, not for the withdrawal phase.
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This is often called the Social Security tax torpedo. It shows up the same way in almost every retirement plan I, as the founder of MOKAN Wealth Management, review for the first time. It’s not a mistake. It’s what happens when there’s no planning for the tax impact of retirement withdrawals.
How the IRS decides what gets taxed
The IRS uses a number called provisional income to decide how much of your Social Security check gets taxed: Your regular income, plus any tax-free interest, plus half of your Social Security benefit.
Once that number crosses certain levels, your Social Security starts getting taxed, and those levels have never been adjusted for inflation.
Married couples filing jointly start owing tax at $32,000 of provisional income. Above $44,000, up to 85% is taxable. Single filers cross at $25,000 and $34,000.
Frozen since the 1980s and 1990s, these thresholds mean a couple with a modest combined income can land at the maximum simply because the numbers are so outdated.
In retirement, income piles on top of itself:
- Your IRA withdrawal gets taxed
- Your Social Security gets taxed on top of that
- Medicare premiums climb along with both
If almost all your savings sit in a traditional IRA or 401(k), every dollar you pull out to pay the bills is fully taxable, and adding half your Social Security on top pushes most retirees past every threshold in year one, often by a wide margin.
Nobody made a bad decision. They just never built a different kind of account to draw from.
The one exception is a Roth IRA. Money pulled from a Roth doesn’t count toward provisional income, doesn’t show up on your tax return and doesn’t raise Medicare premiums. It’s the one source of retirement income the IRS leaves alone.
The three buckets every retirement needs
Think of your savings in three buckets:
- Money you’ve already paid tax on (a brokerage account, where you owe tax only on the growth)
- Money you haven’t paid tax on yet (a traditional IRA or 401(k), where every dollar withdrawn is taxed as ordinary income and where most people hold nearly all their savings)
- Money you’ll never pay tax on again (a Roth IRA, which grows and comes out tax-free and is invisible to the IRS)
When almost everything sits in the second bucket, every dollar you withdraw pushes more of your Social Security into the taxable zone.
Tax diversification means having enough in each bucket to choose which dollars to spend each year based on what creates the smallest tax bill.
Roth conversions: Moving money to the third bucket
The most reliable way to build the tax-free bucket is through a Roth conversion: Moving money from your traditional IRA into a Roth IRA and paying income tax on the converted amount that year.
After that, the money and all its future growth come out completely tax-free and never count toward provisional income again.
The window to do this well is shorter than most people think. It typically opens in the years just before or after retirement, before Social Security starts and before required minimum distributions (RMDs) force taxable income onto your tax return. Income is usually at its lowest point during that stretch, which means lower rates on any conversion done then.
Three approaches work well in practice:
- Filling your tax bracket by converting just enough each year to use up room in your current bracket
- Converting larger amounts over a shorter window when a balance is too large for small annual conversions to move the needle in time
- Converting more aggressively when the market is down, since the same number of shares costs less in tax
The biggest mistake is waiting. RMDs force taxable income onto your return at age 73 or 75 whether you need it or not — on a balance that’s kept growing with the tax bill still attached.
A before-and-after example
John and Karen, both 60, have $1.8 million combined in traditional IRAs, $200,000 in a brokerage account and almost nothing in a Roth. They plan to retire at 63 and need about $150,000 a year to live on. Their combined Social Security benefit is roughly $70,000 at full retirement age, or about $53,000 if they claim benefits early at 63.
On the default path, they retire and claim at 63, then pull the remaining $97,000 they need straight from the IRA. Provisional income comes out to roughly $123,000, well past the $44,000 ceiling: The 85% maximum, or roughly $45,000 of taxable Social Security, stacked on top of the $97,000 IRA withdrawal.
On the coordinated path, starting at 60 while they’re still working, they convert a portion of the IRA to Roth each year, paying the tax from income and the brokerage account so the full converted amount keeps growing tax-free.
They keep converting through their mid-60s and wait until 67 to claim Social Security, when the benefit reaches its full $70,000. By then, the Roth is large enough to cover roughly $40,000 of annual spending tax-free, with the remaining $40,000 from the IRA.
Provisional income lands around $75,000 instead of $123,000: Still above the ceiling, but with substantially less Social Security taxed and a large share of spending arriving with no tax bill.
Same retirement date, same lifestyle spending, a meaningfully different tax outcome for the rest of their retirement. The only difference was starting at 60 instead of waiting until the options had narrowed.
What to do now
Most people don’t choose to pay the maximum tax on their Social Security. It happens because they didn’t plan for it, which also means it’s predictable enough to fix.
Run your own provisional income number. Figure out how much room is left in your current bracket. Then start moving money into the Roth bucket, even a few years before retirement. The window narrows every year you wait.
The Social Security Administration’s benefit estimator and IRS Publication 915 are good starting points for running your own numbers.
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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
