The Retirement Tax Squeeze

For decades, you’ve been told to save for retirement. Put money into your 401(k), take the tax deduction, let it grow tax-deferred, and worry about the taxes later.

That’s not necessarily bad advice.

But eventually, later arrives.

Imagine a retired couple with $2 million accumulated in traditional IRAs. They did exactly what they were supposed to do. They saved consistently, invested for the future, and allowed those accounts to compound tax-deferred for decades.

But there’s an important distinction that can easily get overlooked.

Tax-deferred does not mean tax-free.

At some point, someone is going to pay the taxes on that money.

The question is: Who will pay them, when will they pay them, and at what tax rate?

The First Squeeze: Retirement

While both spouses are alive, their tax situation may be relatively manageable.

They’re filing Married Filing Jointly. They may be receiving Social Security and pension income while taking distributions from their retirement accounts. Eventually, Required Minimum Distributions (RMDs) begin, forcing additional taxable income out of traditional retirement accounts each year.

For many retirees, this is where the first squeeze begins.

You may not need the RMD to support your lifestyle, but the IRS requires you to take it anyway. That additional income can potentially push you into a higher tax bracket, make more of your Social Security taxable, and increase your Medicare premiums.

And as those pre-tax accounts continue to grow, so can the future tax obligation.

But that’s only one part of the story.

The Second Squeeze: One Spouse Dies

Eventually, one spouse may pass away.

Emotionally, that’s one of the most difficult transitions a family can experience.

Financially, it can create another challenge that many couples don’t see coming.

The surviving spouse may still own the same house.

They may still have most of the same retirement assets.

They may still receive pension income, Social Security, and Required Minimum Distributions.

But eventually, they may no longer have the benefit of Married Filing Jointly tax brackets.

The year a spouse dies, the surviving spouse can generally still file jointly if otherwise eligible. Certain surviving spouses with a qualifying dependent child may also qualify for special filing treatment for two additional years. But many retirees eventually find themselves filing as Single.

Now imagine having a similar amount of taxable retirement income flowing through a tax return with much narrower brackets.

That’s the retirement tax squeeze.

The money didn’t disappear. The IRA didn’t disappear. And the tax liability didn’t disappear.

But the amount of income that can fit inside each tax bracket changed.

The Third Squeeze: Your Children

Then there’s one more layer.

Eventually, whatever is left has to go somewhere.

I often think this is an overlooked part of retirement planning because many people will say: “I’m not worried about leaving an inheritance.”

That’s completely fine.

You don’t need to have an inheritance goal for this planning to matter.

Because whether leaving money to your children is a goal or not, we still want to know where the money is likely going.

Under the SECURE Act, many non-spouse beneficiaries who inherit a traditional IRA are generally required to empty the account by the end of the 10th year following the owner’s death.

Think about what that could mean.

Suppose your children inherit your retirement accounts when they’re 50 or 55 years old.

Where are they in life? What does their income look like?

They may be executives, business owners, physicians, attorneys, or simply established professionals experiencing the highest earning years of their careers.

Now we’re taking distributions from Mom and Dad’s pre-tax retirement accounts and stacking that taxable income on top of their own salaries, bonuses, investment income, and other sources of income.

Money that Mom and Dad may have had opportunities to withdraw or convert while in a 12%, 22%, or 24% marginal bracket could potentially be distributed to children who are in significantly higher brackets.

The tax was deferred.

But that doesn’t necessarily mean it was reduced.

Sometimes it was simply passed down the family tree.

The Goal Isn’t to Avoid Taxes

This doesn’t mean everyone approaching retirement should immediately start withdrawing money from their IRA.

And it certainly doesn’t mean everyone should convert their entire traditional IRA to a Roth.

That’s not planning either.

The goal isn’t to avoid taxes at all costs.

The goal is to determine when paying the tax may be most advantageous.

For one family, that might mean strategic Roth conversions during the years between retirement and RMDs.

For another, it could mean intentionally taking additional IRA distributions while they’re in a lower tax bracket.

For someone who is charitably inclined, Qualified Charitable Distributions may eventually become part of the strategy.

And for another family, the best decision may be to do nothing.

There isn’t one answer because there isn’t one retirement.

Look Beyond This Year’s Tax Return

When someone is approaching retirement or already retired, we shouldn’t only be asking: “What tax bracket are you in this year?”

We should also be asking:

What will your income look like when RMDs begin?

What happens to the tax return if one spouse dies?

How much pre-tax money could the surviving spouse eventually have?

What could Medicare premiums look like?

Where are your children in their careers?

What tax brackets might they be in when they inherit these assets?

And ultimately: Where is the money going?

You may have spent 30 or 40 years accumulating retirement assets.

The next phase is figuring out how those assets should be distributed—not just to fund your retirement, but to manage the long-term tax consequences for you, your spouse, and potentially the next generation.

Tax-deferred accounts can be incredibly valuable retirement tools.

But tax-deferred doesn’t mean the tax disappeared.

It means the tax bill is waiting.

Good retirement planning isn’t simply about delaying that bill for as long as possible.

It’s about understanding who is likely to pay it—and creating a plan before the squeeze begins.