6 Tax Penalties to Avoid Before Retiring [Video]

One of the goals of a tax efficient retirement plan is to avoid triggering tax penalties. In this video, we cover six tax penalties you might overlook when preparing for retirement.

Video Transcript

If you think your taxes automatically go down in retirement, you may be in for a surprise.

Hi, my name is Michelle and I’m a financial advisor here at Financial Design Studio. We help business professionals retire in a tax-efficient way. So if retirement is getting close for you, we have a free retirement planning guide that you can download, which is linked below.

Now today we’re going to explore that tax-efficient piece.

What Causes Tax Penalties for Retirees?

Why do tax rules seem to change in retirement? While you’re working, you’re saving money into your retirement accounts to use at some point in the future. And now that you’re retiring, you need to use those funds by withdrawing from those accounts.

The rules actually don’t change. What is changing is your situation, the income you have, and where it’s coming from. There’s a lot of rules surrounding how and when you need to do things. This is where there could be penalties.

So now let’s talk about six tax penalties that you could face headed into retirement.

1. Healthcare Premiums

Now for healthcare, when you are working, you usually get this from your employer. Typically you choose which plan you want, and it’s a set amount that you pay.

Very similarly for healthcare in retirement, you have Medicare, which is a flat amount that you pay. However, depending on your income, you could also have an IRMA surcharge. This is your Medicare premium and it’s based on how much income you earn two years prior.

So each year for your Medicare premium, the IRS looks back two years to see what your income was. And there are tables that shows you different income limits and the IRMA surcharges that you’ll have to pay. Now, even a dollar over those income thresholds for those brackets can bump you into that next Medicare bracket. So it’s very important to plan your income to really put it together and know what you do have, how much you’re paying each year as you take action because it will affect you the following two years.

2. Estate Taxes

Now next on our list could be estate taxes. And there are several things that can affect estate taxes. For example, maybe you receive an unexpected inheritance. It does depend on what you’re inheriting or what type of account you’re inheriting. So if it’s an IRA, if it’s a property, there could be taxes on gains.

Estate tax could also target gifts. So that is either money you’re receiving or that you’re wanting to give. Depending on the amounts, what you are gifting, and or when you receive it, estate taxes could be something that affects you.

Now, when we talk about estate planning, we’re talking about trying to limit the amount of estate taxes that you and your beneficiaries will pay. The questions you need to ask yourself are, what do you want to leave your beneficiaries? How do you want to leave it to your beneficiaries? Or do you want to give and leave things to charities?

All of these pieces matter and shape what you pay or don’t pay in estate taxes by the way you do it, the timing of when you do it. So it’s really important be working through these pieces before you retire. Even in retirement, as your assets continue to grow, we’re still trying to minimize taxes.

3. Early Withdrawals

Let’s talk about early withdrawals. So this, for example, could be someone who’s retiring earlier than the retirement age of 65. So let’s say you are 59 and a half and you need to use your retirement assets that are in an IRA. So you took money out of your 401k, you rolled it over to an IRA right when you retired, but now you need to use that money. Well, when it’s in an IRA, there’s pre 59 and a half penalty for taking those funds out.

This is where you want to think about when you’re going to need that money because, you may actually want to leave those funds in your 401k to avoid that penalty before you retire.

4. Missed RMDs

Next could be missed Required Minimum Distributions, or RMDs. And RMD’s are simply each year the government saying, “this is how much you have to take out of your retirement accounts, your 401ks, your IRAs once you’re retired.” And now these missed RMDs, is the amount you were supposed to take out but didn’t, can be pretty highly penalized. We’ve seen these penalties as high as 50% of the amount you didn’t withdraw. Again, legislation can change what these penalties are over the years. And so it’s really important that you make sure you’re taking out what you need to, when you need to. Tax planning leans into how to use these RMDs strategically!

5. HSAs

Now let’s talk about another account that a lot of people use for retirement. It is really valuable and that is the HSA, a health savings account. And this account is how you’ve saved money for retirement specifically for health expenses. Now this can be used for some health insurance premiums, for example, Cobra or those health costs that you have, like prescription that aren’t paid by insurance.

When you use these funds, you just need to know what is covered and what you can use your HSA for. Otherwise you’re taking money out and then will be penalized because you used it for something that wasn’t allowed. Curious to learn more about how to use your HSA? Read our comprehensive article here!

6. State Taxes

And finally, let’s talk about state tax issues. You might be moving to a different state. Now some states DO tax retirement income withdrawal. And so these are pieces that you need to know about your state. If you’re moving to a new state, you really want to research that before you move so that you know what you’re able to do. And again, that way you’re being tax efficient as much as you can.

How Can You Avoid These Tax Traps?

As we like to say with taxes, timing is everything. That’s the problem though. This is complex and you are just trying to enjoy. Now taxes are just one piece of your retirement plan. If you find yourself wondering if you’re getting everything right, download our free retirement planning guide, which is linked below. In it, we share the two questions we ask each of our clients so they can retire worry free.

Your Next Steps

And if you want a team of financial advisors to support your retirement plan, this is what we do best. Our team specializes in tax efficient retirement planning for individuals with executive compensation. So you stay on track all year, every year, reach out to our team at to schedule a 30 minute consultation.

We’ll see you there or in the next video!

Bonus: Our Free Retirement Planning Guide!