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I recently met with a prospective client who told me that he and his wife have been able to live off of Social Security alone, but they’ve still done an awesome job saving pre-tax assets.
These assets were socked away for years as the couple saved into their pre-tax 401(k) plan – and it helped decrease their adjusted gross income and taxable income as a result.
But now, as they’re realizing that they’ve saved way more than they could ever spend – they are also realizing that Uncle Sam may be coming for his pound of flesh.
Being that the only income they’ve taken in the last several years has been Social Security, they’ve not had any taxable Social Security benefits.
The Incoming Problem
But this is going to change when this gentleman turns age 73 and his Required Minimum Distribution begins.
Required Minimum Distributions (RMDs) are mandatory withdrawals from retirement accounts that begin when you reach age 73 (or 75 for those born in 1960 or later).
While these distributions ensure you use your retirement savings during your lifetime, large RMDs can create significant financial challenges.
What this gentleman learned was that taxes are going to begin to be due – and depending on your financial situation, a large RMD you do not need can present issues.
Here are 5 of the biggest issues I’ve encountered in working with retirees:
1. Taxable Ordinary Income Increases
When you take an RMD from a traditional retirement account, the entire distribution is generally taxed as ordinary income. Large RMDs can create substantial tax consequences at both federal and state levels.
Federal Tax Impact
Large RMDs can push you into higher federal tax brackets, significantly increasing your tax liability. For example, a retiree who would normally be in the 22% tax bracket might find themselves pushed into the 24%, 32%, or even higher brackets due to a substantial RMD.
This bracket creep can result in thousands of additional tax dollars owed to the federal government.
The current federal tax brackets (as of 2025) range from 10% to 37%, and even a moderate increase in your bracket can substantially impact your after-tax income.
Keep in mind, the RMD is fully taxable at the next bracket due to our marginal system.
So for example, if a single taxpayer’s taxable income prior to his RMD is $48,475, (right at the edge of the 12% tax bracket prior to taking the RMD) his next dollar of ordinary income will be taxed at 22% – and so will every dollar thereafter until he reaches the 24% bracket.
State Tax Consequences
While federal taxes affect everyone, state taxes can add another layer of complexity. Depending on where you live, your RMDs may also be subject to state income tax.
Some states, like Florida, Texas, and Nevada, have no state income tax, making them “RMD-friendly.” Other states, such as California, Minnesota, and New York, have high state income tax rates that can take an additional bite out of your retirement distributions.
It’s worth noting that some states offer special exemptions or lower tax rates for retirement income, but large RMDs may exceed these exemptions, resulting in higher state tax bills.
2. Stealth Taxes
Beyond the obvious income tax implications, large RMDs can trigger what many financial planners call “stealth taxes” – additional costs that aren’t direct taxes but function similarly by reducing your spendable income.
Social Security Taxation
As the gentleman I was talking with came to the realization – Social Security Benefits could be taxed if enough ordinary income is realized in a given year.
Without large RMDs, many retirees might keep most of their Social Security benefits tax-free. However, as your modified adjusted gross income (MAGI) increases due to RMDs, more of your Social Security benefits become taxable:
- Up to 50% of benefits are taxable when your combined income exceeds $25,000 (single) or $32,000 (married filing jointly)
- Up to 85% of benefits are taxable when your combined income exceeds $34,000 (single) or $44,000 (married filing jointly)
For many retirees with substantial IRAs, large RMDs can cause maximum taxation of their Social Security benefits, effectively creating a stealth tax that reduces their retirement income.
IRMAA Surcharges
The Income-Related Monthly Adjustment Amount (IRMAA) is another stealth tax that can significantly impact retirees with large RMDs. IRMAA imposes higher Medicare Part B and Part D premiums for beneficiaries whose income exceeds certain thresholds.
These surcharges effectively create a tax that can amount to thousands of additional dollars annually for healthcare costs, directly resulting from large RMDs increasing your MAGI.
3. Capital Gains and NIIT Concerns
Large RMDs don’t just affect the taxation of the distributions themselves; they can also impact how your investment income is taxed.
When your taxable income exceeds certain thresholds due to large RMDs, your long-term capital gains and qualified dividends face higher tax rates. Instead of the preferential 0% or 15% rates, you might pay 20% on these investment returns.
Additionally, the Net Investment Income Tax (NIIT) imposes an extra 3.8% tax on investment income for individuals with modified adjusted gross income above $200,000 (single) or $250,000 (married filing jointly). Large RMDs can push you over these thresholds, subjecting your investment income to this additional tax.
For example, a married couple with $240,000 in income might normally avoid the NIIT entirely. However, if an RMD pushes their MAGI to $260,000, they would suddenly be subject to this additional 3.8% tax on their investment income.
One thing to keep in mind is that the NIIT thresholds are fixed. So if a pre-tax account grows in value, thus pushing up MAGI due to a higher RMD, more investment income could be subject to that tax.
4. Investment Concerns
Beyond tax considerations, large RMDs can create investment management challenges that affect your long-term financial security.
Down Market Withdrawal Risks
One of the most significant risks associated with large RMDs is the requirement to withdraw substantial amounts from your retirement accounts regardless of market conditions. This can create a sequence of return risk.
When markets are down, large RMDs force you to sell investments at depressed prices, permanently locking in losses and reducing the potential for recovery when markets rebound. This can dramatically impact the longevity of your retirement portfolio.
For example, taking a $50,000 RMD during a 20% market downturn means selling investments worth $62,500 at their previous value. This “buy high, sell low” scenario is exactly the opposite of sound investment strategy but becomes unavoidable with mandatory large RMDs during market downturns.
If you don’t take the RMD, you are subject to a 25% penalty of the amount you should have taken – so there is no good outcome in this scenario.
Unlike discretionary withdrawals that can be adjusted based on market conditions, RMDs offer no flexibility. You must take the distribution regardless of whether it’s an opportune time from an investment perspective.
5. Legacy Concerns
For many retirees, leaving a financial legacy to heirs or charitable organizations is an important goal. Large RMDs can significantly impact these legacy plans in several ways.
First, by forcing accelerated withdrawals from tax-advantaged accounts, large RMDs can deplete these accounts faster than you might prefer. This reduces the potential for tax-deferred growth that could otherwise benefit your heirs.
Second, the taxes paid on large RMDs throughout retirement can substantially reduce the overall estate available for heirs. Money paid to the IRS is money that won’t benefit your loved ones or favorite charities.
The SECURE Act’s elimination of the “stretch IRA” for most non-spouse beneficiaries further compounds this problem. Most heirs now must withdraw inherited retirement accounts within 10 years, potentially during their peak earning years when they face their highest tax rates.
What This Person (and You) Should Do
This couple’s story isn’t unique—and it’s a powerful reminder that saving diligently into pre-tax retirement accounts is only half the equation. The other half is understanding how and when to draw down those assets in a tax-efficient way. Without proper planning, large RMDs can create a domino effect of taxes, surcharges, and reduced flexibility that ultimately erodes the wealth you worked so hard to build. The good news? With proactive strategies—like Roth conversions, charitable giving, or rethinking asset location—you can take back control and reduce the bite Uncle Sam takes in retirement. Don’t wait until RMDs force your hand—start planning now.