Consider these tax-saving moves ahead of your RMD birthday.
Many people in the early years of retirement — after they stop working but before they are mandated to take required minimum distributions (RMDs) at age 73 or 75 from qualified retirement plans — find themselves in a lower federal income tax bracket. Known as the “early retirement window,” this period offers retirees a strategic opportunity to take certain steps that can help their money last longer and provide flexibility around future income.
My team, alongside your tax professional, can help you determine which financial strategies may be beneficial to you in these early years of retirement.
Here are six early retirement tax planning strategies to consider:
1. Prioritize tax-deferred accounts
Because you can make withdrawals from tax-deferred accounts without any penalties once you reach age 59½, consider prioritizing withdrawals from those accounts while you’re in a lower tax bracket. By doing so, you will reduce future RMDs and can save your non-taxable assets, such as Roth accounts, for years when your income is higher.
2. Redeem older savings bonds
While in a lower tax bracket, you may want to cash in U.S. savings bonds issued when interest rates were higher.
3. Exercise employee stock options
If you own employee stock options, you can save money by exercising them while in a lower tax bracket — especially if the current stock valuation is high.
Advice spotlight
Avoid the retirement “tax torpedo.”
It’s common for retirees to be pushed into a higher tax bracket when they begin withdrawing more income to cover expenses or as RMDs. Taking proactive financial steps prior to this time can help you lower your taxable income, how much of your Social Security is taxed and potentially avoid Medicare surcharges.
4. Consider a Roth conversion
Roth conversions allow you to convert pretax contributions to an IRA or employer retirement plan to a Roth IRA. Though you will pay taxes on the converted amount in the year it happens, you will also decrease the amount of pretax assets subject to RMDs, giving you more control over your income in the future and providing flexibility in managing taxes.
Once the money is in the Roth IRA, any growth is tax-free (if certain conditions are met), and you won’t owe taxes on it again. That means the money won’t count toward the “combined income” used to calculate taxes on Social Security benefits or in the calculations used to determine the Medicare premium surcharge or the net investment income tax (NIIT) on investment income.
Roth IRA conversion calculator
Use this calculator to see how converting your traditional IRA to a Roth IRA could affect your net worth at retirement.
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5. Explore your eligibility for the 0% capital gains rate
The tax rate on long-term capital gains — assets held beyond one year — is based on your taxable income. If you have stocks, mutual funds, bonds or other taxable investments that have appreciated significantly and are held outside a qualified retirement plan or IRA, it may make sense to sell those investments in the early years of retirement, when your taxable income is lower.
Some, or all, of net long-term capital gains may even be taxable at the 0% capital gains tax rate if your total taxable income falls below the threshold for your filing status. Even above the income thresholds, however, the long-term capital gains rate is more favorable compared to the ordinary income tax rate.
6. Find out if NUA makes sense for you
If you have highly appreciated employer stock in your company’s qualified retirement plan, you may want to consider taking advantage of the net unrealized appreciation (NUA) tax treatment.
With NUA, you withdraw the employer stock from your employer plan as a lump-sum distribution and then transfer it in-kind to a taxable brokerage account. By doing so, you will be taxed on the distribution at the long-term capital gains rate, rather than the ordinary income tax rate you’d eventually be subject to if you rolled it over into an IRA or left it in the employer plan.
This tax strategy may help reduce your tax burden and can be especially beneficial if you're in a lower tax bracket. However, NUA is a complex, one-time only opportunity that comes with specific requirements and several tradeoffs, so you’ll want to consult your tax professional to see if it makes sense for you.
Get help while in early retirement and beyond
We can work with your tax professional to determine which early retirement strategies can help you manage your taxes and make your retirement income last longer.