3 Common Tax Return Surprises for High-Net-Worth Retirees
Episode 36
3 Common Tax Return Surprises for High-Net-Worth Retirees
Published on May 20th, 2026
Episode Summary
Episode 36 of Retirement Tax Matters identifies common situations where retirees in the $2M–$8M range experience April 15th tax surprises. Garrett and Adam detail how the lack of automatic federal withholding on Social Security benefits can create a federal tax shortfall, though recent updates to SSA.gov now allow you to update your Social Security federal withholding online. The discussion also warns about the IRS interest penalty that can be applied to late-year Roth conversions, where failure to determine the best way to pay federal taxes on large Roth conversions can result in underpayment penalties. The third area is high-net-worth retirees with large brokerage accounts where invisible income (capital gains, reinvested dividends, etc.) becomes taxable only to realize it come tax time when the bill comes due. By implementing tax-return driven financial planning and intra-year projections in October, families can identify these surprises early, reinforcing why high-net-worth retirees need both tax preparation and tax planning. This strategic approach helps high-net-worth retirees ensure surprise tax bills are minimized as much as possible.
Key Tax Planning Questions
Question 1: Why do I owe federal taxes on Social Security?
If I had a nickel for every time I’ve heard this question, I might be able to fund the Social Security trust fund myself! Most of us are conditioned to think about taxes in terms of our federal tax filing each April, but the IRS has a myriad of ways to tax your income, and Social Security is often the most frustrating.
First, we must delineate between two separate taxes. The first is the Social Security payroll tax, the 6.2% you paid as an employee (or 12.4% if you were self-employed) to fund the benefits of those retired before you. Now that you are the recipient, the younger generation is returning the favor.
However, the tax that catches high-net-worth retirees off guard is the federal income tax on the benefits themselves. For almost every retiree in the $2M–$8M range, you will pay federal taxes on 85% of your Social Security benefits at your ordinary income rates. This is because the IRS uses a formula called combined income, and for married couples, once that number exceeds $44,000, 85 cents of every Social Security dollar becomes taxable. While it is true that 15% of your benefit remains federally tax-free, the remaining portion is simply viewed as another source of ordinary income stacked on top of your RMDs and pensions.
The real surprise occurs during the online enrollment process. For reasons known only to the Social Security Administration, the standard online application does not currently include a screen to elect federal tax withholding. Most retirees are accustomed to the W-2 world where the IRS takes its cut before the check hits the bank. When they sign up for a $4,000 monthly benefit and see only Medicare premiums deducted, they assume they are in the clear. If a couple has $75,000 in annual Social Security income and fails to set up withholding, we commonly see a federal withholding shortfall the following April.
We encourage retirees to revisit their SSA.gov accounts after benefits begin to utilize the newer functionality that allows for online withholding adjustments. If you are married and both receiving benefits, I generally prefer that both spouses elect the same federal withholding rate. This level of consistency makes it much easier for me as a financial planner to perform an accurate current year income estimate. Proactive Social Security benefits federal tax withholding is a simple step that replaces a unexpected April surprise.
Question 2: Why is there a penalty on my Roth conversion?
If I am being honest, this is one of the more challenging conversations I have with clients regarding Roth conversions. At the heart of the issue is a simple reality: the federal government is not in the business of providing free loans to its citizens. To illustrate why a penalty often appears on a tax return even when the tax was paid, let's use an extreme example.
If John performs a $1,000,000 Roth conversion on January 1, 2026, and the associated tax bill is 35% (or $350,000), he might be tempted to wait until the following April 15 to settle that bill. John might think it is a great deal to keep that $350,000 working in his own accounts for 15 months. However, the IRS views this as a foul. Because the U.S. tax system is a pay-as-you-go model, they expect their portion of that income at the time it was realized.
If you do not pay your share of taxes in a timely manner, the IRS assesses an underpayment penalty. In 2026, that interest rate is currently between 6-7%. Years ago, when these rates were much lower many retirees found paying the penalty was a minor cost of doing business. In the current climate, a 6-7% penalty on a large tax bill is a significant tax drag that most financial planners would recommend avoiding.
To stay on the right side of the rules, a retiree needs to consider three primary paths:
Estimated Tax Payments: Making a $350,000 payment to the IRS by the end of the first quarter.
Federal Withholding: Instructing your custodian to send the 35% directly to the IRS from the IRA funds. While this is the simplest path, it is often less efficient because it reduces the amount of capital moving into the tax-free growing Roth.
The Safe Harbor Shield: Utilizing rules that protect you from penalties if you have paid in a specific amount (as determined by formula) of prior year’s tax liability (for those with high incomes).
The real trap for high-net-worth retirees occurs in the fourth quarter. It is my experience that most conversions happen late in the year because families don't know their final income numbers until November or December. Even if John makes his estimated tax payment the same day he executes a December Roth conversion, the IRS does not automatically see that payment as timely. By default, the IRS assumes your income was earned evenly starting in January.
To fix this, your tax preparer may need to file IRS Form 2210 using the Annualized Income Installment Method.* This essentially tells the IRS that your income didn't exist in the first three quarters, so you shouldn't be penalized for not paying earlier. This level of detail is exactly why determining the best way to pay federal taxes on large Roth conversions is such a vital part of our tax-return driven financial planning process.
* This is a complicated process. Verify with your tax preparer!
Question 3: Do I pay taxes on capital gains I didn't receive as cash?
For many high-net-worth retirees in the $2M–$8M range, there is a high correlation between their success and the presence of large brokerage (non-retirement) investment account. Often, these accounts started small decades ago and were managed without much tax thought. However, through continued disciplined savings or the incredible performance of a legacy stock, these accounts eventually reach a critical mass. Retirees can feel like they’re losing control of their taxes because their return shows taxable income significantly higher than the amount they actually received in their bank account to live on.
This phantom income (income not seen in your bank account) primarily comes from two sources: reinvested dividends and realized capital gains. The trap for the unwary is the belief that if you don't touch the money, it isn't taxable. Unfortunately, the IRS has a different view. They say a reinvested dividend or a portfolio rebalance as a completed transaction. If a security is sold for a profit or a company pays a dividend, a taxable event has occurred regardless of whether you moved that cash to your checking account or used it to purchase more shares. In large accounts, these internal movements can generate a tax bill that rivals or surpasses the high-income salary years of your working career.
A specific challenge with these accounts is that, unlike a traditional IRA or a 401(k), custodians generally do not allow for federal tax withholding on brokerage sales. This puts the burden entirely on you to monitor your investment income and make timely estimated tax payments. If you wait until April to settle the bill, you may find yourself hit with an underpayment penalty on top of the actual tax owed. This is especially critical if you are in a unique tax planning zone between retirement and before Social Security and RMDs start and are evaluating tax bracket jumps from Roth conversions. It is nearly impossible to know how much you can safely convert to a Roth IRA if you haven't first calculated the floor of taxable income your brokerage account is generating.
As a financial planner I find that the bigger the brokerage account, the more gravity of influence it exerts on your retirement plan. Most retirees would do well to have a proactive strategy to manage taxes year-to-year. By tracking your realized gains in October and November, you can make an informed decision on whether to harvest losses to offset those gains or prepare an estimated payment to the IRS, ensuring that the growth of your wealth doesn’t make the IRS your biggest beneficiary.
Full Episode Transcript
Adam: Good morning and welcome to Retirement Tax Matters. I'm Adam Reed. This is Garrett Crawford, our resident CFP® professional. How are you doing this morning, Garrett?
Garrett: We're back.
Adam: We're back. We are doubling up on some episodes this morning, so same outfits. In the social media world, you always have one in your back pocket in case someone's sick or one of us is traveling. It's funny, I just asked you about 10 minutes ago, "How are you doing this morning?" so I assume you're doing the same.
Garrett: I'm doing great still.
Adam: Not much has changed. The last podcast didn't throw you off and ruin your day or anything. That’s good to hear. We just finished up some different series, and we wanted to do a standalone episode that I think is a good one for anybody, really. Whether a 25-year-old or someone in retirement stumbled across our podcast, we wanted to talk today about some major landmines you can step on that cause tax shock come April 15th.
You’ve submitted all your tax documents, you did your planning the previous year—you did tax return-driven financial planning—it went great, and you’re so excited. Then you get your return and all of a sudden there’s a tax bill there that you weren’t expecting, or something that’s a little bit higher than what you anticipated. We wanted to talk through a few of those common things. I’m sure we’ll do a follow-up episode in the future on other things that could blow up in your face, but let’s look at three of those things. Garrett, maybe you can lead us into the first one on your mind.
Garrett: Honestly, this thing that Adam and I do, and I think it's going to get more popular in the future, is this idea of tax return-driven financial planning. The reason we do it—one, is there's a lot of value on the table for people listening. I think that's one of the best ways a CFP® professional can help build wealth: through prudent tax planning decisions and helping you work through that on a year-by-year basis. What I’ve found in doing it is that you cannot underestimate the peace of mind that comes with avoiding tax surprises.
Just like people hate paying Medicare IRMAA penalties where they have to pay more for Medicare than their friends, people just hate getting surprised by a tax preparer when they fill out their return and they say, "You still owe $7,000. Are you okay with that?" People go, "What? What happened? Did I not pay enough?" People generally never respond well to a surprise multi-thousand dollar tax bill. Part of our business is helping our clients build wealth systematically with small wins each year. The other part is just the psychological benefit where we prevent those surprises.
The top three things today—or three common areas I’ve seen in my years doing this—have provoked a surprise from a client that was preventable had you gotten out in front of it. Number one is a common mistake that generates an April 15th tax surprise: when people get ready to sign up for their Social Security benefits. They’re excited; they’re finally getting money out of the system that they’ve paid into, in their mind, entirely too much for. They are on the SSA website signing up for their benefit. Maybe their check is going to be $3,000 a month, and they know Medicare will probably get deducted, but the idea of federal withholding either slips the mind or doesn’t come up.
The Social Security website—and I’ve watched clients go through the sign-up process—has no screen on the online process where you can set up federal withholding. For a lot of people, a Social Security benefit might be $36,000 or $40,000. When they go through the online sign-up, they are accustomed to seeing a net amount where federal withholding is automatically taken care of, like when they were working. But what’s actually happening is that their Medicare premiums are being deducted, but not federal tax.
In that first year of retirement, if they don’t take the steps to do federal withholding, they end up having $40,000 or $50,000 of additional income that is taxable. Technically, 85% of it is taxable income. They end up significantly under-withholding on their income, they go to their tax preparer, and find they owe $5,000. It was all because they started Social Security but didn’t take the steps to do the federal withholding.
One side thing here: federal withholding used to have to be done on a paper form. You couldn’t even go online to change it. I would print off SSA Form 4V, sign it, elect what federal withholding you want, and mail it into your local Social Security office. It just got dropped a lot of the time, and usually, it isn't until somebody ends up paying extra tax that they say, "Maybe I should do some federal withholding."
Adam: Isn’t it funny? That sounds archaic. It sounds like you said you had to walk down to the watering hole and fill out a form.
Garrett: The good news is that, as of last year, you can now log into your Social Security account and adjust that federal withholding. For a lot of retirees, that’s something they do once when they’re signing up, and then they throw that login away and it’s an act of Congress to get back in. But while you’re signing up, you can go in and adjust that federal withholding. That is one way you can prevent a tax surprise: by filling out that form online and electing 10%, 12%, or 22% federal withholding. Adam, what's a second way a client can get hit with an April 15th tax surprise?
Adam: It’s funny, the last few episodes we recorded, we haven’t talked a lot about Roth conversions. You and I were chomping at the bit. How do we get Roth conversions back in the conversation?
Garrett: That was the whole goal of this episode, just to talk more about Roth conversions.
Adam: Just so you could toss me a freebie to hit a home run on the topic. We love Roth conversions; we think they are a great tool. But there are ways you can get in trouble with them. Tax return-driven financial planning helps you avoid those things by looking at IRMAA levels and marginal tax brackets. But there are a few tricky nuances.
There are two ways to satisfy the Roth conversion tax bill. The simplest and perhaps least efficient is to do federal tax withholding. That would avoid this situation because that withholding is done the day you do the conversion. The other way, which is the more optimal, efficient way but has more steps involved, is making an estimated tax payment for your Roth conversion. You convert your IRA funds to the Roth and then pay out of pocket—perhaps out of a brokerage account—by writing a check or submitting a payment to the IRS.
One of the tricky things there is, especially in the fourth quarter, if we do a big conversion—say $100,000—at a 20% tax bracket, that’s $20,000 in taxes you owe. The IRS doesn't necessarily appreciate the fact that you were a good steward and made the estimated payment on the same day. You feel like you did a great job and can just sit back and relax. Well, if we’re not careful and not working with the tax preparer to ensure this information is put in correctly, the IRS can say, "That Roth conversion might as well have been done on January 1st." Since the IRS interest rate is around 7% right now, they can look at $100,000 and say you waited too long to make your estimated payment. All of a sudden, with interest added, you have a decent little tax bill that makes you feel like you're being punished for doing what you were supposed to do.
Garrett: And the tax preparer will use the word penalty. Everybody hates a surprise penalty.
Adam: You just feel that burning feeling in your stomach where you don’t know if you’re angry or upset.
Garrett: It’s usually not even about the amount; it’s about the surprise of having done something wrong.
Adam: Right. That is why it’s so important as we’re doing this tax return-driven financial planning to be in high communication with your financial professionals. Whether it’s your financial advisor and your tax preparer, make sure all parties are communicating. Tell them, "Here is when we’re doing the Roth conversion, this is the amount, and here is how we make sure these things are reported correctly."
Garrett: When clients work with us, this is table stakes. If someone does a $50,000 Roth conversion, we have the conversation that this is taxable and you have to pay the taxes now. I have seen in my professional experience meeting with people who have done a Roth conversion and just weren't tracking with the fact that they owed taxes on that money. They just assume Schwab or Fidelity is going to take care of all the taxes. Well, then you have an extra $50,000 on your income. I don’t want to insult the intelligence of the people listening, but that is something out there where people end up with this big tax bill because they forgot they had to pay taxes on that conversion.
Adam: The last one for today is one we just ran into with a client. The planning looked great, but those sneaky brokerage accounts can have invisible gains. Tell me more about that and how those have to be on our radar come tax time.
Garrett: I could do a soapbox on this for a whole episode. Brokerage accounts—not an IRA, 401(k), or Roth—are investment accounts in your name where you are taxed as you go. They are the most complicated investment accounts from a tax perspective. If you are retirement age and take distributions from an IRA every year, you get a 1099-R showing the amount you pulled out. Those forms have been going out over the past couple of months, and they are so simple; you take out $40,000, you get a three-page envelope, and it lists your name, the amount, and federal withholding.
The Roth IRA is also super simple. You still get a 1099-R, but it’s not taxable because you’re older than 59 and a half. The brokerage account, however, is a different story. You get an envelope from Schwab and it’s no longer three pages; it’s 67 pages. You wonder what is going on in your investment account that takes 67 pages to report. It’s the nature of a brokerage account. There are different tax rules for what you own, how long you own it, and the tax rate applied. For example, a collectible long-term capital gain rate is around 28%, not the normal 15% to 20%. These forms have to account for every buy and every sell, unlike an IRA where it’s just money in and money out.
This is honestly one of the biggest ones that catches people. It’s not uncommon for a high-net-worth retiree with $2 million to $8 million to have a brokerage account similar in size to their IRA. When you withdraw from an IRA, you have the option for your advisor or custodian to ask how much you want withheld for taxes. But have you ever noticed that your advisor or custodian never asks how much you want withheld for a withdrawal from a brokerage account?
Withholding is disallowed on those accounts. We cannot tell the custodian to withdraw 15% for long-term capital gains. We can only send the amount of the distribution, and then it’s the client's job to either withhold more from their IRA money or pay an estimated tax. As for invisible income, that’s stuff happening in that really large brokerage account—maybe there is turnover and things are sold. It triggers a capital gain in 2026 which you have to pay taxes on, but because it’s just buying, selling, and reinvestment, you never see that money in your bank account.
I was looking at a tax return the other day where the adjusted gross income was $250,000, but they had a $150,000 long-term capital gain from other things we did. Their return shows $400,000 in income, and 150 of that was from long-term capital gain in a brokerage account. At a 20% tax rate, that’s $30,000 in taxes owed. As a planner, I've learned that if you don’t get out ahead of that, it’s a black eye. Clients might be okay with paying the tax at the time of the sale, but if months go by, they forget why you were doing the planning and they end up getting hit with a big tax bill that an estimated tax payment should’ve been paid on. Your brokerage account is the sneaky big one. The income it generates could rival the high-income salary years you had while working.
Tax return-driven financial planning spends a lot of time focusing on the brokerage account: tracking embedded unrealized gains, optimizing tax brackets between 15% and 20%, and helping our clients know when to make an estimated tax payment so they don't end up with a surprise.
Adam: That is the perfect segue for our year-end tax planning checklist. It touches on most of these things: make sure we're keeping an eye on these. Honestly, it was so much harder years ago to keep up with unrealized and realized gains, but it’s becoming easier. If you aren’t tech-savvy, it’s worth sitting down with a grandchild or your advisor and asking for a crash course on how to find your gains online. Whether you are at Schwab or Fidelity, it is easier than ever to find that information.
Garrett: I organize that checklist by seasons. In the fall—October and November—that’s when you’re dialing in these brokerage accounts. That’s when we look at unrealized and realized long-term capital gains to make final execution decisions for the end of the year. It’s a helpful framework.
Adam: If you are self-managing, you have more control over long-term versus short-term gains. If you’re working with an advisor, make sure you communicate that to them. We have portfolios that prioritize long-term capital gains, but some advisors just care about the rate of return. If you like this tax return-driven financial planning, those are the conversations you should be having with the people you work with. Check out the year-end tax planning checklist in the link below. find us on Apple, Spotify, and YouTube. Like, subscribe, and follow. We appreciate you tuning in. I’m Adam Reed. This is Garrett Crawford, CFP® professional. We're Retirement Tax Matters.