Tax Bracket Planning in Early Retirement


By: Jaime Ruff


We often work with people who have saved enough to stop working and live off of their investments in their early 60s or sooner. The mindset many have as they begin retirement is to spend after-tax investments first and to postpone withdrawals from tax-advantaged accounts like IRAs until required at age 70½. It can be alluring to pay very little in income taxes in the years before IRA distributions have to be taken but deferring too much can actually push future income into a higher tax bracket. In the end is that the most tax-efficient approach?

It may be better to purposely generate some taxable income in early retirement, thereby paying income taxes sooner than required. In creating a financial plan for our clients we often find that a combination of withdrawals from taxable accounts and IRAs is optimal. The idea is to generate some income in early retirement to fill up a lower tax bracket in order to prevent that income from being taxed at a higher rate in later retirement.

One of the best tools available for generating income is the partial Roth IRA conversion. Making partial Roth IRA conversions in early retirement helps nail down the optimal income tax rate, while at the same time reducing the balance of the IRA that will be subject to minimum distributions in the future. The icing on the cake is that the amounts moved into the Roth can now grow tax-free and are not subject to minimum distributions during the retiree’s lifetime. This creates a third “bucket” or type of savings account to invest differently than the others, to potentially tap into in the future, to leave to heirs, etc.

Last but not least, the lower tax rates enacted in the Tax Cuts and Jobs Act of 2017 are scheduled to sunset in 2026, which makes the idea of pre-paying taxes even more appealing between now and then. After sunset, if your RMDs are high enough, you could get nudged into a higher bracket. Converting now means taking advantage of today’s lower rates while they last.

There are of course some “gotchas” to watch out for. Depending on the circumstances, generating income like this can not only trigger income taxes, but it may generate negative consequences that have to be considered in the big picture. Things like greater taxation of social security benefits, higher Medicare premiums, loss of subsidies for health insurance, and reduced deductibility of medical expenses, may be factors. As with most financial planning ideas, there are pros and cons that should be considered in every unique situation.

Homrich Berg is a national independent wealth management firm that provides fiduciary, fee-only investment management and financial planning services, serving as the leader of the financial team for our clients.