Middle millionaires worth $1-$3 million fork out the most to the IRS. Dodge the tax torpedo headed for your nest egg now

For many Americans, a nest egg of $1.46 million in 2026 is seen as the key to a comfortable retirement, according to a Northwestern Mutual survey. However, nearly 655,000 Americans have already reached this milestone, holding seven-figure retirement accounts. While this may seem like a dream come true, these millionaires often face a different reality - they may be more susceptible to a "tax torpedo" that increases their tax burden.

The U.S. tax code is progressive for lower-income earners, with exemptions and credits available to protect them from paying excessive taxes. But for middle to upper-income retirees, this protection is less available. The One, Big, Beautiful Bill Act (OBBBA) introduced in 2026 provides an additional $6,000 deduction for individuals aged 65 and older, reducing the federal tax bill for some retirees.

However, the majority of income for the ultra-wealthy comes from sources like selling shares of private businesses, dividends, capital gains or rental income from properties. These methods often receive favorable tax treatment. For instance, a capital gains exclusion of up to $15 million allows wealthy individuals to exclude up to 10 times their investment from taxation when selling a small business.

But for conventional millionaires - those who earned their wealth primarily through wages and retirement account withdrawals - the tax situation is different. A 4% annual withdrawal from a $1.5 million 401(k) plan, combined with Social Security income, might push their income high enough to make up to 85% of their Social Security benefits taxable. Additionally, a withdrawal of $120,000 could trigger Medicare IRMAA surcharges, especially for those with more than $3 million in retirement savings.

The tax burden for traditional millionaires increases as they draw down their retirement accounts, particularly when combined with Social Security income and investment income. Required Minimum Distributions (RMDs) at 73, which will rise to 75 in 2033, further complicate matters.

To mitigate this tax situation, Morningstar suggests spending some tax-deferred money earlier. This approach can help defuse the tax torpedo, ensuring a more financially secure retirement.