tax planning window for retirement

The Tax Planning Window for Retirement

The Tax Planning For Retirement

The Tax Planning Window is defined as the period of time after you stop earning income and before you are required to start social security and required minimum distributions. This is the optimal time to do tax planning for retirement.

For the tax savvy individual, The Tax Planning Window is a glorious time! There is no other window in time where you have such control of how and when you recognize income. During your tax planning window, you can decide exactly how much you are going to pay in taxes!

Do not ignore your tax planning for retirement, because the goal is: pay the least in taxes over your lifetime. A dollar less you pay in taxes is a dollar more you can enjoy in retirement, or leave as a legacy.

A Window is a good analogy because it opens and closes.

Open Window For Retirement Tax Planning

The window opens when you have access to your 10 and 12% tax brackets (or sometimes 22 or 24%) due to the fact you don’t have earned income filling them up!

Even better, below the $12,400 or $24,800 standard deduction for single or joint fillers, respectively, you can access income tax-free!

Use this Tax Planning Window wisely, because it closes when you are forced to take income again.

Close Window for Retirement Tax Planning

There are several ways your tax planning window closes.

First, when you take social security, you will pay taxes on up to 50 or even 85% of social security depending on your “provisional income.” Half them money you get from social security counts for provisional income, so most high earners should just assume they will have to include 85% of their social security as fully taxable. Taxation of social security is complicated.

Second, you will be forced to take required minimum distributions (RMDs) from you pre-tax accounts. Currently, thanks to the SECURE Act, you are forced to take ever increasing RMDs at 72.  At 70, however, you will still claim social security as there are no more delayed income credits beyond that age.

Finally, other sources of income can be recognized as ordinary. Pensions and annuities are common sources of partially (say annuities from your brokerage account) and fully taxable income (pensions, and annuities from tax-deferred accounts).

But wait, there’s more! Of course, there are more sources of income that can fill up your brackets!

Alimony (prior to 2018-after that it stops being a tax deduction), business income (Schedule C), Schedule E income, Schedule F income, Form 4797… even Capital Gains!

Capital Gains Stack on Top of Ordinary Income, but can negatively affect your Tax Planning Window.

I know this is a lot to take in, but the Tax Planning Window is very important! Let me tell you why.

Why the Tax Planning Window is so Important

Control. Yes, you can control how much you pay in taxes.

For a traditional retiree who retires at 65, you have less than 5 years to access your low tax brackets.

For Financial Independence, the glory of being FI is prolonged access to your Tax Planning Window. This leads to a whole host of other issues (like what income is most tax-advantaged to live on) that is the bread and butter of FIRE.

Beyond control- flexibility. You get to decide when to do partial Roth conversions.

Partial Roth Conversions and the Tax Planning Window

Some people get confused and think there is an income limitation on Roth conversions. There is not. There are limitations on contributions, but not conversions.

If you have money in your pre-tax account, you can (usually) just press a button and convert that money to Roth money, paying taxes now.

These partial Roth conversions are amazingly powerful!

You use your standard deduction, and the 10 and 12% tax brackets to do Roth conversions. This means paying much less now on taxes then you will in the future once RMDs force the un-taxed income out.

Having at least some money in Roth accounts is important for good tax diversification and to control your income in the future.

Let’s look at an example of partial Roth conversions and visualize the Tax Planning Window.

The Tax Planning Window Visualized

The Tax planning Window

Figure 1 (The Tax planning Window)

Note in figure one that income stops at retirement (age 60). The brackets are demonstrated by the colored lines, and there is no income in the example until social security starts at full retirement age (currently 66 or 67 years of age). At age 72, RMDs begin and the tax planning window closes.

There is a clear window in time when you can access your 10 and 12% tax brackets. You need to fill these up!

Some folks only use their brokerage account during this time and allow their tax-deferred accounts to grow. This is usually a bad idea, as you will increase the taxes you pay latter via RMDs. Again, the goal is to pay the least amount of taxes over your lifetime. Use the standard deduction, and the 10 and 12% tax brackets to pay some tax now so you pay less taxes in the future and overall.

Note the taxes paid above quickly go above the 22 and 24% tax brackets due to just social security and RMDs on the pre-tax accounts.

Partial Roth conversions can shift this money into tax-free Roth accounts during the tax planning window.

An Example of Partial Roth Conversions and Tax Planning in Retirement

tax planning in retirement

Figure 2 (An example of partial Roth conversions and tax planning in retirement)

Note in figure 2, there is now a dark blue shape filling the 10 and 12% tax brackets during the tax planning window. These are the partial Roth conversions!

Also, note in the future, this decreases RMDs and keeps them out of the 24% tax bracket in the future (which actually is the 28% bracket once TCJA expires after 2025).

You might think that this isn’t a big deal, going down two percent from 24 to 22. But you would be wrong! And don’t forget, 22 becomes 25 and 24 becomes 28 when Tax Cut and Jobs Act expires in 2026 (or sooner if Biden is elected).

Remember, during your tax planning window you are paying taxes at very low effective rates. When you are forced to take RMDs, all of the money comes out “on-top” of everything else, at your highest marginal tax bracket. Keep your effective tax rate low over your whole life by decreasing the amount of income included at your highest marginal tax brackets.

Tax Bracket Arbitrage

The long and the short of it; this is tax bracket arbitrage. Use your lower tax brackets effectively to keep out of your higher brackets later in life. This is especially important for those folks who are high income and use tax-deferred accounts during their working years to lower taxes.

A lot of annuity and Life Insurances salesman talk about the evils of tax-deferred accounts, but they are short sighted. If you have to pay taxes at some time, you might as well pay now they say. Well, that is only part of the story.

Remember to use tax bracket arbitrage and pay taxes when you have less income rather than more income. What is the total of taxes now and in the future?

Tax Planning for Retirement and the Tax Planning Window

What does this control offer you? What is the advantage of never taxable money?

Once you have Roth money, you can pull the money out without any implications to your taxes.

Decreased RMDs from your always taxable accounts are huge. In addition, there are no RMDs from Roth accounts! Efficient tax planning for your Heirs is a major consideration with partial Roth conversions.

With Roth money, you also have the ability to control your provisional income if you want to pay less in taxes from your Social Security.

What about health care? Controlling your income can get your premium ACA tax credits for Obama Care plans. And when you get to Medicare age, IRMAA is a huge deal. Medicare plan B and D are subject to large surcharges if you make too much money.

In the end, it is all about control. Who knows what the future will hold, especially in regards to tax rates set by Congress?

Understand your Tax Planning Window. Tax Planning for Retirement is your best chance to keep the money you earned rather than paying through the nose in taxes.

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3 Comments

  1. Great topic. You touch briefly on ACA premiums and IRMAA. My wife and I are in our third year of early retirement. We walked away from our careers at 51/52 years old respectively, so we have a large planning window to play with. We decided to leave work when we realized we could manage our income to receive ACA subsidies and therefore have access to health insurance at a very low cost due to the subsidies. Our assets are roughly 50% rental properties and 50% tax deferred account assets. The rental property income provides all of our primary early retirement income until we can access tax deferred assets. With real estate income we have very large depreciation shelters to control taxable income levels at this time (keeping our MAGI low for ACA). We have a significant amount income to meet our needs with the rental income alone, while our tax deferred accounts continue to grow, but this presents a future RMD tax issue. Unfortunately, we have no Roth assets at this time because we didn’t have this option early in our careers (at typical lower earning levels), and later, we were not yet financially sophisticated enough to perform back door conversions (during our higher earning years). So we find ourselves in a predicament where the ACA subsidies (~$15K per yr) essentially force us to not do Roth conversions (as they would force us to exceed the ACA Cliff), as we are able to stay just under the subsidy cliff threshold currently. Now after three years of receiving ACA subsidies, I’m realizing that I should consider forgoing the subsidy and paying full price for ACA, so I can fill up our available tax brackets with Roth conversions. We would pay approximately $170K between now and Medicare age for ACA premiums out of pocket (based on our ages and current ACA premiums with inflation), but it appears we can save over $200K in the long run in taxes by doing Roth conversions now. By considering taxes and insurance premiums costs as one big retirement cost, it appears we might be better off (over the long term) to forego subsidies and lower our tax costs with Roth conversions in the long run. I know there are opportunity costs to consider on the subsidy payments, etc., but my math keeps telling me the subsidies are a possible long term trap on the back end from a tax perspective. Have you run across anyone else in this situation? I’m obviously trying to validate my thoughts on these golden handcuff subsidies. Another advantage of forgoing the subsidies is that we could consider drawing from tax deferred accounts sooner (also further leveling out taxes) giving us greater cash flow in our younger (more active) retirement years. (Who knew tweaking retirement would be so much work!!) Thanks again for all the great articles!

  2. I first want to say I enjoy your website and your analytical mindset. Keep up the good work.

    I have a very simple question but wanted to make sure I am seeing things properly. I see a lot of talk about the tax planning window and how to convert your retirement funds into Roth IRA and put the money in the lower to tax brackets. I’m currently 64 years old and I don’t think I am a financial aberration for doctors but maybe I am. I’m still working part-time but even if I stop working this year, my passive income from taxable accounts and other royalty payments would put me over $200K and in the 24% tax bracket. Am I safe to assume that when you talk about the tax planning window having 10% and 15% buckets when they stop work that means they have no income from dividends or bonds or royalties that would be taxable (or their income is less than $100K/year)? Does that mean almost everything they have is in their retirement accounts as opposed to taxable accounts?

    I did some recent calculations on RMD’s and with my present retirement account balance, and a 6% return until I am 72 years old than my RMD’s will be over $200K per year to start. I don’t foresee myself having any 10% or 15% buckets to fill over the next few years. They will already be full. My safe to assume that this tax planning window for me is kind of a moot point? Thanks for any help in clarifying this for me. Just looking for another opinion.

    • Remember that the ordinary taxes are not affected by dividends and long term capital gains. K1, W2 and 1099 (and some other types of income) will fill up the lower brackets.

      Some people, if they have enough pre-tax money, will easily be pushed into 32%/35/37+% tax brackets by RMDs and doing Roth conversions in the 32/35% tax brackets can make sense. It just depends on the amount of pre-tax money you have and your sources of on-going income in retirement. You need to project what your RMDs are into your 80’s. Don’t just do a tax projection at age 72, do one for the next 20-30 years!

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