How to avoid tax torpedoes in retirement

Retirement is supposed to be a time of financial ease, not surprise tax bills. Yet many retirees—especially those who’ve diligently saved—find themselves hit with unexpected tax spikes triggered by routine income flows. UBS calls these sudden jumps in marginal tax rates “tax torpedoes.” The culprits? Required minimum distributions (RMDs), Social Security, and Medicare premium thresholds. This article unpacks how tax torpedoes work, why they often catch retirees off guard, and what you can do today to steer around them.

A “tax torpedo” is a term used to describe the sharp, unexpected increase in effective tax rates during retirement. It usually occurs when withdrawals from tax-deferred retirement accounts—like traditional IRAs and 401(k)s—interact with other income sources, such as Social Security and investment income.

Here’s the trap: These different income streams don’t just add up. They interact in ways that push more of your Social Security into the taxable bracket, raise Medicare premiums (via IRMAA surcharges), and push you into higher marginal tax brackets—sometimes without actually increasing your spending power.

Imagine thinking you're in the 12% tax bracket, but thanks to income thresholds and Medicare rules, you're effectively paying 30% or more on your next dollar withdrawn. That’s the tax torpedo.

UBS and other financial planners often point to three overlapping systems that create tax torpedoes:

1. Required Minimum Distributions (RMDs)
Once you hit age 73 (or 75 if born in 1960 or later), the government requires you to start withdrawing from your traditional retirement accounts. These RMDs are taxable income—even if you don’t need the cash.

2. Social Security Taxation
Social Security becomes partially taxable when your “combined income” exceeds certain thresholds. Combined income includes adjusted gross income (AGI), nontaxable interest (like from municipal bonds), and 50% of your Social Security benefits. That means even modest IRA withdrawals can make 85% of your Social Security taxable.

3. Medicare IRMAA Surcharges
Medicare Part B and D premiums rise as your income increases. The surcharges (called IRMAA: Income-Related Monthly Adjustment Amount) kick in at specific thresholds. Unlike tax brackets, these are cliff thresholds: miss them by $1 and pay hundreds more annually.

These three layers compound. One dollar of IRA withdrawal could cause a dollar of Social Security to become taxable, which in turn nudges you over a Medicare threshold, costing you far more than the initial withdrawal would suggest.

Let’s say you’re a 68-year-old retiree with a $1 million traditional IRA, moderate investment income, and $40,000 per year in Social Security. You delay RMDs but begin modest withdrawals to supplement your income. Then at age 73, RMDs kick in at over $40,000 a year—pushing your AGI high enough to make up to 85% of your Social Security taxable and triggering Medicare surcharges. Even though your spending habits haven’t changed, your tax bill suddenly jumps thousands of dollars. This isn’t a problem limited to the ultra-wealthy. In fact, middle-income retirees with most of their wealth in tax-deferred accounts are often the most vulnerable.

Avoiding tax torpedoes doesn’t mean avoiding taxes altogether—it means smoothing your income path to reduce unnecessary spikes. Here are four aligned planning strategies UBS and many fiduciary planners recommend:

1. Strategic Roth Conversions Before RMD Age
Consider converting a portion of your traditional IRA to a Roth IRA during lower-income years (usually in your 60s before RMDs or full retirement age). This can lower your future RMDs and create tax-free income flexibility later.

2. Delay Social Security Strategically
If you can afford to, delaying Social Security to age 70 can reduce overlap between taxable IRA income and benefit taxation in your early 70s. This also increases your guaranteed monthly benefit.

3. Manage Income Cliffs
Stay below IRMAA thresholds where possible. For example, keeping your modified adjusted gross income below $103,000 (individual) or $206,000 (married) avoids a higher Medicare surcharge bracket in 2025. Use qualified charitable distributions (QCDs), municipal bonds, or Roth withdrawals to fill income gaps without raising AGI.

4. Use Tax Buckets for Withdrawal Sequencing
Diversify across tax buckets: taxable (brokerage), tax-deferred (IRA/401k), and tax-free (Roth). This allows year-by-year control over how much taxable income you report—giving you tools to manage brackets and avoid triggering multiple systems simultaneously.

Whether you're five or fifteen years from retirement, the path you’re on matters. Ask:

• What percentage of my retirement savings is in tax-deferred accounts?
• Have I modeled how RMDs affect my tax bracket and Medicare premiums?
• Am I using my low-tax years (e.g., early retirement) to reposition assets strategically?
• Do I have flexibility across tax buckets to make withdrawals tax-efficiently?

These questions aren’t about optimization for optimization’s sake—they’re about keeping more of what you’ve earned, and avoiding compounding penalties you didn’t see coming.

Not every tax torpedo is obvious. Here are subtle triggers that can sneak up:

• Capital gains stacking: Selling a highly appreciated asset may bump AGI just enough to tip IRMAA or make more Social Security taxable.
• Inherited IRAs: Non-spouse beneficiaries must now withdraw inherited IRA funds over 10 years, which can lead to big tax spikes in high-earning years.
• One-off income events: Even a large annuity payout, home sale, or part-time consulting income can push you into dangerous territory.

The danger with tax torpedoes isn’t just the tax—it’s the illusion of control. You think your income is steady, your withdrawals modest, and your tax plan sound—until overlapping systems say otherwise. But clarity helps. With enough time and planning, these risks can be minimized or avoided entirely. Roth conversions, withdrawal sequencing, and proactive Social Security timing aren’t gimmicks. They’re how smart retirees build flexibility into their future.

You don’t need to master the tax code. But you do need to make decisions aligned to your timeline, income flexibility, and long-term goals. Because the best retirement plans don’t just focus on the rate of return. They focus on what you get to keep.