Lower Your Taxes in Retirement: The Gap Years


It’s entirely possible to lower your taxes in retirement with just a little bit of planning on the front end. The “gap years” – the years between retirement and age 72 when your IRA Required Minimum Distributions (RMDs) begin – offer the perfect opportunity to take advantage of two overlooked tax-saving strategies.

Tax-deferred retirement accounts such as your 401(k) are a great way to save for retirement while simultaneously lowering your taxes during your working years. Unfortunately, those funds are taxed when you start withdrawing them in retirement. Those withdrawals will only increase when you turn 72 and Uncle Sam forces you to begin withdrawing a minimum amount each year.

But what if you can reduce the amount you’re required to withdraw? That’s where the gap years of retirement come in. By teeing up one of these overlooked strategies in your relatively low-income years, you could potentially lower the total amount of taxes you pay over your retirement.

By the way, everyone’s tax situation is different, so be sure to consult with your CPA or tax professional before putting one of these strategies into play. Until then, please consider this to be helpful information rather than personalized advice.

Strategy 1: Partial Roth Conversions

If you’ve done any sort of retirement or investment research, you’ve no doubt heard of a Roth IRA or Roth 401(k). Once your savings are in a Roth account, any future withdrawals are tax-free. It’s a great deal, especially if you have time to invest and grow the funds.

But there’s typically a significant hurdle in getting money into a Roth account. During your working years, you may earn too much to make a direct contribution. Of course, there are always Roth IRA conversions – where you pay income taxes on IRA assets to convert them into Roth IRA assets. You can convert as much as you want each year, but then again, a relatively high marginal tax rate may mean you’re overpaying for the conversion.

In your gap years, however, your taxable income may be much lower – making a Roth conversion much more cost-effective than it would be during your prime earning years.

Working with your CPA, you can determine the amount of your IRA to convert into Roth assets that will take you to the top of your tax bracket in any given year. It’s a tax-efficient way to make Roth conversions.

Another overlooked benefit of this strategy is that it also lowers the total amount of your IRAs. By reducing the total value of your tax-deferred investments during your gap years, you effectively reduce the amount of your RMDs – and the associated taxes – later in life.

You pay a little in taxes now to save a lot later.

Strategy 2: Zero Capital Gains Taxes

Strategic partial Roth IRA conversions are one of my go-to strategies for retirees in their gap years. However, there’s another strategic opportunity available if the conditions are right. If your income is low enough, you could potentially take advantage of a zero long-term capital gains tax rate.

If you find yourself heading into retirement with large capital gains in some of your investments, this strategy may be preferable to a partial Roth IRA conversion, even if it’s only used for one year. Tax laws change, of course, but in 2022, married couples with taxable income under $83,350 and single filers with taxable income under $41,675 can take advantage of zero percent long-term rates.

Of course, realizing long-term capital gains adds to your taxable income, so there’s a limited amount you can cash in for zero taxes each year. In addition, there’s the very real possibility that tax laws change in the future, so be sure to consult with your CPA to zero in on the amount of gains you should harvest.

Now that we’ve discussed the strategies, let’s examine three factors that can help you maximize them.

Factor 1: Social Security Timing

For either of these tactics to make sense, you’ll need a relatively low taxable income. Most retires can expect a lower tax rate in retirement, however, any recurring income such as Social Security or pensions can reduce the impact of these tax savings strategies. If you don’t need
Social Security income to support your retirement living expenses right away, delaying until age 70 will give you more space during your gap years for tax planning.

Delaying your Social Security until age 70 not only increases the opportunity during your gap years, but also increases the amount of benefit that you’ll eventually receive. Your monthly payments increase by 8% for every year you delay. If you don’t need the current cash flow and you’re relatively healthy, there’s a dual benefit.

Factor 2: Other Retirement Income

While you may have some discretion on when you can start your Social Security retirement benefits, other retirement income such as pensions tend to offer fewer timing choices. If you have a pension, start factoring that income into your tax strategy ahead of time. While pensions may make tax planning more difficult, they do tend to increase your chances of having a successful retirement in general.

Don’t forget the details of your pension in tax planning. If you expect to begin receiving benefits on your 65th birthday – and your birthday is in December – you’ll still have a tax-saving opportunity that year.

Other income such as rental property income or earned income from employment will affect your opportunities to lower your taxes in retirement. Of course, sit down with your CPA as you begin to map out your plan.

Factor 3: Charitable Contributions

For the charitably inclined, there’s another consideration when planning to lower your taxes in retirement: qualified charitable distributions (or QCDs). A QCD allows you to make a direct contribution from your IRA to any 501(c)(3) registered charity.

One of the great benefits of QCDs is that they can satisfy some or all of a given year’s required minimum IRA distribution. Rather than withdraw and pay income taxes on your RMD, you can simply donate it to charity. You save on taxes while potentially giving more money to the charity you were going to support anyway.

Of course, there are plenty of rules you’ll need to observe if you want to want to take advantage of making qualified charitable distributions, including a limit of $100,000 of total gifts.

When it comes to creating your retirement tax plan, QCDs will likely come into play after your gap years are over. This may look like a conscious decision to be less charitable than you’d otherwise be during your gap years while being more generous after your RMDs begin.

Can You Lower Your Taxes in Retirement?

Everyone’s situation is different, so choosing between strategic partial Roth conversions and zero long-term capital gains taxes during your gap years depends on multiple factors. However, for those who are planning to retire soon – or for those who have recently retired and have a few gap years left – these two strategies certainly have the potential to lower your total tax bill in retirement.

If you need help creating a tax plan for your retirement gap years, then click here to set up a quick, complimentary introduction call to see if Prana Wealth is a good fit. We do still have the capacity to take on new clients.

As a fee-only financial advisor in Atlanta, we can (and do) work virtually with clients all across the U.S. and we’re here to help you when you’re ready.

The information contained herein is intended to be used for educational purposes only and is not exhaustive. Diversification and/or any strategy that may be discussed does not guarantee against investment losses but is intended to help manage risk and return. If applicable, historical discussions and/or opinions are not predictive of future events. The content is presented in good faith and has been drawn from sources believed to be reliable. The content is not intended to be legal, tax, or financial advice. Please consult a legal, tax, or financial professional for information specific to your individual situation.
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