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Making the Most of your Tax Brackets in Retirement

Author: Michael Brocavich, MBA

Regardless of your politics, many retirees (and non-retirees) will benefit from lower taxes due to the Tax Cuts and Jobs Act put into effect in January of 2018.  With the increase in the standard deduction and lower tax rates, taking income from your retirement accounts could cost you less in taxes than in previous years.  This gives retirees an opportunity to do some strategic income and tax planning in the early years of retirement before you have to start taking Required Minimum Distributions ("RMD") from your Qualified Retirement Accounts.

First, it’s important to look at some of the significant tax changes that came with the Tax Cuts and Jobs Act. The standard deduction for 2019 has increased to $12,200 for single filers and $24,400 for joint filers.  For married couples over the age of 65, they also will have an additional $1,300 deduction each. Add that all up and joint filers who are both 65 or older will have a standard deduction of $27,000.  That means that your first $27,000 of income will be federal tax free! 

Additionally, the new tax laws have reduced the 15% tax bracket rate to 12%.  For married filing jointly, the top of the 12% tax bracket for 2019 is $78,950.That means that retirees age 65 and older could potentially have up to $105,950 of gross income and still remain in the lowest tax bracket.  Understanding the tax laws along with taking money from the right accounts at the right time could help to reduce your future taxes all through retirement and to reduce taxes significantly for your heirs.

Strategies for Retirees

1) Roth Conversions - If you’re like most retirees, you do not have substantial assets in your Roth IRA, if you even have one at all.  With Income limits on Roth contributions and clients preferring to save in tax deductible accounts first, many older taxpayers never opened Roth IRA’s.The early part of retirement gives you an opportunity to strategically take money from your IRA and convert it to a Roth IRA.  There is no income limit or even minimum dollar amount requirements to do Roth conversions, but you have to be aware that pulling money from your Traditional IRA and moving to your Roth IRA is a taxable event.  By understanding your tax situation in retirement you can move money into your Roth IRA and pay tax at lower rates than you potentially would later in retirement while building tax free assets and reducing your future RMD’s (Required Minimum Distributions).

Common sense would tell you to try and take income and pay the least amount of taxes possible.  This is prudent, but a lot of retirees either forget about or don’t truly understand their future RMD’s and their impact to taxes in the future.With RMDs on Qualified Retirement Accounts at age 70 1/2 many retirees will be forced to withdraw more money from their Qualified Retirement accounts than they need and will have to pay taxes on those distributions.  You are able to take money strategically out of these qualified retirement accounts and convert the funds to Roth IRA accounts that do not have minimum distributions at 70 ½..  This in turn will reduce the values in your Qualified Retirement accounts, reducing your future RMD’s and giving you more tax-free assets for you to use in retirement or to pass on to your heirs.

Investor situation:


John CindyTotals
Age6565
Taxable Assets$500,000$500,000$1,000,000
IRA Assets$1,000,000$500,000$1,500,000
FRA Social Security$24,000$12,000$36,000

(This is a hypothetical example for illustration purposes only)

John and Cindy are now ready to retire at age 65 with a desired retirement income of $100,000.  Typically it would be suggested that they take their Social Security at their full retirement age of 66 and use their taxable brokerage account for retirement income, delaying WD’s from their IRA’s till 70 1/2.  In this scenario, their taxes could be minimal as 85% or less of their Social Security would be taxed and with a standard deduction of $27,000, their Federal Income Taxes would be only a couple thousand dollars or less depending on the capital gains they realized.  What is not being considered is that with just a modest growth rate on their Qualified Retirement Accounts of 6%, when they reach 70 1/2 they could have an RMD of $85,000 - $90,000 giving them much more income than they really need. 

If they were to delay taking Social Security to age 70 and do a Roth Conversion of $60,000 per year to top out their 12% tax bracket from ages 65 through 69, they could reduce their future RMD’s to be more in line with their retirement income needs, reducing their future taxes and building a substantial tax-free Roth IRA.  In addition, they would also benefit with the delay in social security, giving them their maximum benefit assuming they have good longevity.

Base Scenario, no Roth conversions, SS at 66

AgeTotal RMD’sTotal Federal Income Taxes PaidTaxable AccountIRA AssetsTotal Assets
6400$1,000,000$1,500,000$2,500,000
90$2,859,393$551,045$2,247,003$2,272,940$4,519,943

(Assumptions: Annual rate of return of 6.0% with a $100,000 per year income adjusted for inflation at 2.58% per year.  Social Security income uses a 1% COLA)

Utilizing Roth Conversion Strategy, $60,000 converted annually, SS at 70 1/2

AgeTotal RMD’sTotal Federal Income Taxes PaidTaxable AccountIRA AssetsRoth IRA AssetsTotal Assets
6400$1,000,000$1,500,0000$2,500,000
90$2,326,151$458,429$1,485,697$1,849,063$1,348,960$4,683,720

(Assumptions: Annual rate of return of 6.0% with a $100,000 per year income adjusted for inflation at 2.58% per year.  Social Security income uses a 1% COLA. This is a hypothetical example for illustration purposes only and does not represent an actual investment))

So let's examine what happened here:

  • Over their lifetime they took $533,000 less in required minimum distributions by doing the conversions, much of which would have been taxed at the 22% tax rate vs 12% rate;
  • They are passing on $1,348,960 in Roth IRA assets to their children that can grow and never be taxed;
  • They are passing on $761,306 less in IRA assets to their children which will be taxed over time at whatever rate applies to the children as adults; and
  • In total the heirs are getting an additional $164,000 than they would have had as well as the assets are now positioned to be much more tax efficient going forward.

2) Harvesting tax gains - For clients like above that have also been able to save not only in Qualified Retirement accounts but also brokerage accounts, there may be an opportunity to harvest taxable gains in the first years of retirement as well.One other advantage of the 12% (formally 15%) tax bracket is that capital gains realized up to the top of the 12% bracket are not taxable to the account owner. 

For retirees that have brokerage accounts, this gives you an opportunity to sell stocks or mutual funds that you have held for a long time with large gains in them.  You are then able to use these highly appreciated funds for income in retirement or to simply rebalance your brokerage account to reduce risk and future taxes. 

Combining the two strategies would create multiple advantages.  By using your assets in your brokerage account for income in the first years while converting IRA assets to Roth IRA you can potentially convert more  money to a Roth  while still staying in the 12% tax bracket.  You will have to be aware of the amount of long term capital gains you realize as the combination of those gains and your conversions could put some of your taxable income over the 12% tax bracket threshold.

Optimizing withdrawals in retirement is a complex process that requires a firm understanding of tax situations, financial goals, and how accounts are structured. However, the 2 simple strategies highlighted here could potentially help reduce the amount of tax due in retirement.

It's important to take the time to think about taxes and make a plan to manage withdrawals. Be sure to consult with a tax and financial advisor to determine the course of action that makes sense for you.

Keep in mind that there is no assurance that any strategy will ultimately be successful or profitable nor protect against a loss. You should discuss any tax or legal matters with the appropriate professional.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. The above situations described are hypothetical in nature.  Any opinions are those of Michael Brocavich and not necessarily those of Raymond James.