Income Tax Strategies in Retirement

Income Tax Strategies in Retirement

With Thanksgiving around the corner, I am thankful we have some light at the end of the tunnel. Pfizer, Moderna, and now AstraZeneca have announced that preliminary data show that their vaccines are over 90% effective. Although there are still some hurdles like storage at subzero temperatures and distributions, I am starting to list all the things I would like to do post-COVID-19.

As we are starting to have year-end planning meetings with our clients, a topic that has often come up in these conversations is tax reduction strategies. While we are not CPAs, we do analyze and provide pro-active tax advice around taxes during retirement. Everyone’s situation is different, but our focus is on reducing the tax burden over the entire retirement period for our clients, not just the current year. In this newsletter, we share industry best practices that are used to maximize tax efficiencies throughout retirement. These strategies consider withdrawal amounts, timing of withdrawals, and Social Security.

Taxes Can Be Tricky – Here are Four Strategies to Help Minimize Your Taxes

For the retired, taxes can be a tricky discussion.  During your working years of accumulating savings, you’ve been enjoying pre-tax deferment through your 401k or IRA plans. But now that you’ll need to start making withdrawals from those accounts, being strategic about which retirement bucket you pull from first can pay off in a big way.

Below, I have highlighted four concrete tax reduction strategies that we can use to help minimize how much you’ll owe the IRS.

#1 Pay Your Yaxes Early in Retirement

The first thing you should do when you need retirement income is to start making withdrawals from those accounts where you will owe federal taxes. These would be accounts like your:

  • Traditional 401k
  • Traditional IRA
  • Self-employed IRAs (Solo 401k, SEP IRA, or SIMPLE IRA)

It may be tempting to want to begin making withdrawals from your tax-sheltered Roth-style accounts since you won’t owe any taxes. However, given that your withdrawals and income may be involuntarily increased due to Social Security benefits and RMDs (required minimum distributions) from your traditional-style accounts, then it would be best to delay taking any withdrawals from your Roth accounts just yet.

#2 Max Out Your Marginal Tax Bracket

In addition to focusing on your traditional style-accounts, you should take this process one step further by withdrawing as much as you can to max out your current marginal tax bracket. Remember that relative to historical tax rates, current rates are at an all-time low.

The U.S. federal tax system is divided into seven marginal tax brackets. As you get further into retirement and the IRS forces you into making more withdrawals, you would likely end up entering into one of these higher tax brackets and end up owing more in taxes than you normally would for these withdrawals.

To avoid this, one often recommended strategy is to reduce your traditional accounts at the beginning of retirement as much as possible by taking out more money than you actually need. That way, you’ll pay the current tax rate instead of a higher one. These extra withdrawals should be placed into another investment account so that you continue to earn compound growth for years to come and the distributions in later years may qualify for long term capital gains rates which are lower than ordinary income tax rates. This strategy makes sense for retirees that foresee a need for additional liquidity within the next seven years.

Example: Let’s say that you and your spouse file your taxes as “married, filing jointly”. Your taxable income currently is $100,000 and therefore taxed at a rate of 22%. The next tax bracket of 24% doesn’t occur until your taxable income is over $171,051.

To alleviate some of your tax burden in the future, you decide to withdraw an additional $71,051 to increase your taxable income from $100,000 to $171,501. You can then turn around and buy stocks, ETFs, or mutual funds and potentially reduce your future tax liabilities by paying long term capital gains versus ordinary income on future withdrawals (depending on the date of withdrawal).

#3 Begin Making Roth IRA Conversions

TWhile this strategy starts with withdrawing funds from taxable retirement accounts, the key differentiator is that this strategy is for retirees that do no need access to funds being converted in their retirement accounts for the next 7-10 years, as this is considered to be the breakeven point for Roth conversions given the upfront tax payment.

For many high-income earners, it was not possible to make contributions to a Roth IRA since eligibility phases out as you make more money. Once this income ends in retirement, it becomes a key planning point to convert the funds from traditional taxable retirement accounts (i.e. 401k, IRAs) to Roth IRA accounts. The advantage of moving it into a Roth is that there would be no taxes due on the principal or earnings ever, which can be a huge savings over time! Further, Roth IRAs are not subject to required minimum distributions.

The reason why we focus on Roth IRAs from an estate planning standpoint is that this investment vehicle helps avoid the widows tax trap. Once a spouse passes, the surviving spouse will lose a standard deduction and is now in the single taxpayer bracket. These changes make a higher percentage of your income taxable at a higher tax rate. Roth IRAs can provide tax free income to a spouse or children in their prime earning years.

Example: Again, using the same example as above, instead of withdrawing the extra $71,051, we could elect to convert this amount over to a Roth. You’d again be taxed at your current marginal tax bracket which in this instance is 22%. However, the future withdrawals from the Roth would then be tax-free. And if one spouse passed away, the surviving spouse with no Roth conversions would have to pay approx. 65% more in income taxes at the same income level of $100k.

#4 Delaying Social Security

Finally, even though most people can begin taking Social Security benefits starting at age 62, it would be better from a tax perspective if you can wait until age 67 (when you are eligible for your full benefit) or even delay it until age 70 (when your benefits are at their maximum).

Again, once you start collecting benefits, you will owe ordinary taxes on up to 85% of this income. Together with your other income sources and RMDs at age 72, this could push you into a higher tax bracket.
If, for example, you were to wait until age 70 to begin taking Social Security, and had managed to move a significant portion of your retirement savings into Roth or taxable brokerage accounts, then you’d have a much better chance of staying within your current (lower) tax bracket.


These four strategies are well tested and are the cornerstones of our retirement income tax projections. Everyone’s situation is different with different income needs and different life events but this serves as a good outline of how we approach your income taxes in retirement. Keep in mind that when we evaluate your situation, and we are trying to maximize income tax scenarios that make sense for your family. If you have any further questions please feel to contact us. Also please don’t forget to check out our Q& A video.