The Most Overlooked Tax Planning Strategy for Retirees
- Travis Tsukayama, CFP® CFA
- 5 days ago
- 3 min read
Tax planning as you enter and live out your retirement years can appear complicated. There are new strategies and products that pop up every year. There are new tax rules and income limits to be aware of. If you work with a CPA or tax professional, you also want their blessing on your tax-savings strategy before trying anything new.
The strategies we believe work best to accomplish this are not complicated. The key to great tax planning is consistency, dedicating time to reviewing your tax situation every year. Much of this work should be done early in the year while you still have time to take action.
When I do tax planning for retirees, I strive to achieve one simple goal: minimize your lifetime tax bill.
Minimizing your lifetime tax bill means intentional tax planning to reduce the amount of federal and state taxes you pay over the span of your life. It doesn’t mean prioritizing paying the least amount of taxes in the current year or looking to get the biggest refund possible.
Of course, we need to make some predictions about the future. We don’t know what tax rates will be in the years ahead. We don’t know how our own financial situations may change by factors outside of our control. Some of the assumptions that influence tax planning are best-guesses based on the information we have today.
In some cases, your tax planning will lead you to pay more in taxes this year than you expected to. That might seem counterintuitive to some – but it may be the right move if it means you’ll pay less in taxes in the future and ultimately lower the taxes you pay over your lifetime.
That brings me to the point of today’s post. One of the most overlooked parts of tax planning is using up lower tax brackets by recognizing income now.
Intentionally filling up lower tax brackets can be good for those who believe their tax rate will be higher in the future than it is today. If you are making less income due to being retired and haven’t yet started your Social Security benefits and Required Minimum Distributions, chances are your income and income taxes will be higher in the future.
Another benefit is flexibility. Pre-paying the income tax on your retirement assets gives you the control of when taxes are paid and when assets are withdrawn from your account.
Tax rates apply only to the income within that bracket. You are not paying a single tax rate on all your income.
Example: A single tax filer pays 10% federal tax on income between $0 - $12,400.
12% on income between $12,401 - $50,400
22% on income between $50,401 – $105,700
Your next dollar being taxed at 22% vs. 12% is a notable jump. If you earned $40,000 of taxable income for the year, you have $10,400 of room to recognize income at the 12% tax rate before entering the 22% bracket. Your tax plan should recognize where these break points are and have a way to capitalize.
Retirees often do this by implementing an annual review that considers Roth conversions, which accounts to withdraw from, and how their investment income affects their taxes.
If your financial advisor has never planned for your tax strategy in retirement, you may be missing out on important savings. We help our clients understand which tax bracket they are currently in and compare it to their expected future tax bracket.
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