Wade Pfau: Watch Out for These Tax Pitfalls in Clients' Retirement Planning

"The after-tax return on an investment is a lot more important than the pre-tax return," he says.

Pfau, founder of Retirement Researcher and co-host of the "Retire With Style" podcast, just published the third edition of his "Retirement Planning Guidebook: Navigating the Important Decisions for Retirement Success." It's an A-to-Z information reference that goes wide and deep, he offers, while being "more user friendly" than the previous edition.

In the interview with Pfau, who is also a professor of practice at the American College of Financial Services, he discusses changes in tax laws for 2026 and touches on tax pitfalls, tax maps, the tax torpedo and deduction bunching.

Here are highlights of our conversation:

THINKADVISOR: Why is tax planning so important for clients' retirement?

WADE PFAU: It can have a big impact on the long-term sustainability of retirement assets. You can meet your retirement goals and have hundreds of thousands of dollars more.

The whole tax-planning thing is about looking for opportunities to voluntarily pay taxes when you can do so at lower rates to avoid having to pay them at higher rates later.

THINKADVISOR: Any changes in tax laws for 2026 that are critical for advisors to know about and pass along to clients?

PFAU: One big one is that the Tax Cuts and Jobs Act of 2017's tax rates, which were set to expire this year, are now permanent.

THINKADVISOR: Please talk about the tax breaks for people age 65 and older.

PFAU: There are two 65-plus bonus deductions. One has been around for [a long time]. For single people, for example, the standard deduction this year is $16,100. But if you're 65 or older, you add $1,650 to your deduction, adjusted for inflation.

The new bonus deduction for those 65 or older is that they get to add another $6,000 to their below-the-line deduction. This one phases out with income. For singles, that begins at $75,000.

THINKADVISOR: Are there any changes to Social Security taxes?

PFAU: Social Security is still taxed the same way as before, and that's completely separate [from income tax].

THINKADVISOR: You write about tax maps. Please explain what they are.

PFAU: You do these when you're thinking about the tax impact of generating income. It's not just about income tax rates.

Tax maps show the effective marginal tax rate of each dollar of income, which incorporates all other considerations: the impact on Social Security, preferential income stacking, Medicare premium surcharges and the phase-out of deductions.

It's usually easier to do this near the end of the year because you need to know all of what your other income will be. That includes distributions from any taxable investment.

THINKADVISOR: What are pitfalls when it comes to taxable income?

PFAU: The way to think about tax planning is that it's not just income taxes; Social Security is taxed too, as I noted.

If you [land] in the "tax torpedo" because you have additional income that's taxed, this causes more of your Social Security benefits to be taxed. So you get a double-whammy.

Another pitfall concerns the [Medicare surcharge] IRMAA — income-related monthly adjustment amount. That is: When your income exceeds certain thresholds, it will cause you to pay higher Medicare premiums two years later.

Then there's preferential income stacking. That's how your long-term gains go on top of your other income. If you don't have much other income, you might be in the 0% bracket.

But as you generate more income, it will be taxed at 12%, pushing some of your long-term gains from 0% to 15%. So then you have a 27% effective marginal tax rate.

THINKADVISOR: Are there any other pitfalls to be aware of?

PFAU: A number of deductions phase out, in addition to the age-65-and-older deduction we just talked about.

Charitable contributions now have a floor — only the amount in excess of half a percent of your AGI is deductible.

THINKADVISOR: If someone is planning to retire soon, it seems that, in addition to their accountant, they should find out if their advisor is well versed in tax planning. Right?

PFAU: Yes, especially on the financial planner side. Many CPAs just want to minimize taxes for this year and don't think about the long-term consequences.

THINKADVISOR: Please elaborate on why it's smart to pay some income taxes early.

PFAU: If I have a situation this year where I've met my expenses and still have some capacity to generate more income, I could do it at a lower tax rate.

Either I'm in a lower tax bracket and therefore wouldn't have the Social Security tax torpedo problem or maybe I'm still pre-Medicare. Then I can do some Roth conversions and pay those taxes this year.

That will help lower my required minimum distributions in the future, which could be beneficial to my tax situation.

This is if you're retired and haven't started Social Security. That can be a really good opportunity because if you're not retired, you already have more income and a higher starting base.

THINKADVISOR: What's key to remember in choosing between tax-deferred and tax-exempt accounts to hold assets?

PFAU: The goal is to pay taxes when the marginal tax rate is lowest.

With tax-exempt accounts, including Roth IRAs, you pay tax on the funds before contributing. Tax-deferred plans will eventually be subject to required minimum distributions that generate taxable income.

THINKADVISOR: So, advisors really need to think about reducing clients' taxes in a smart way. Right?

PFAU: Yes. The after-tax return on an investment is a lot more important than the pre-tax return. That speaks to things like asset location: You generally would not want bonds in a taxable brokerage account if you can help it.

Put your low-cost, tax-efficient U.S. stock index funds in your taxable account. Funds that are less tax-efficient, like small-cap value or emerging markets, could be in your Roth account or tax-exempt accounts.

THINKADVISOR: Please explain when the tax strategy of bunching would be beneficial.

PFAU: You don't get any tax benefit from charitable deductions if they're not large enough if you just using your standard deduction.

The bunching idea is that rather than contribute to a charity every year and not get any tax benefit, you bunch maybe five years of charitable contributions into one calendar year.

That gets you over the standard deduction so that you can realize some real tax benefit.

THINKADVISOR: Do-it-yourself investors probably don't think about tax planning and strategies. Agree?

PFAU: Yes. People might just default to 60/40 stocks and bonds in each of their accounts. That's not so tax-efficient.