I will be posting a three-part series over the coming months about tax planning leading up to and including early retirement. This is part one.
We've had quite a few clients who retired in the past two to three years, and this creates unique tax planning opportunities.
I call the period between age 60 and 70 the “golden decade of tax planning.” Why do I call it that? Because if you retire in your early 60s, you have a once-in-a-lifetime opportunity to do proactive tax planning before you reach age 70 that can potentially reduce your future lifetime income taxes by tens of thousands of dollars!
You will be in that rare period of your life when you are not working and earning an income, but when other uncontrollable income has not kicked in yet. I will explain what I mean by “uncontrollable income” in my next blog post, but it is essentially income that once it starts, you can’t stop it or really control the amount. One example would be a required minimum distribution (RMD) from your retirement plan—which is all taxable as regular income, of course.
What Are the Factors Behind the Golden Decade of Tax Planning?
- You can take retirement plan distributions starting at age 59.5 without a 10% tax penalty, so you can fine-tune what you take and not worry about tax penalties.
- RMDs from retirement plans don’t start until age 70.5, so you can let your retirement assets grow as we tap other sources of income.
- You can delay Social Security until age 70. Delaying has the benefit of not only reducing taxable income but also allowing your benefits to grow. (For related reading, see: Top 6 Myths About Social Security Benefits.)
- Once you retire, your income usually drops dramatically. Suddenly, your taxable income is now in brackets you only saw decades ago when you started working.
- If your taxable income is low enough, you can harvest long-term capital gains at 0%. Yes, you really can harvest long-term capital gains without paying any taxes.
- Reducing your IRA balances during the golden decade will reduce your future required minimum distributions. This has the benefit of reducing future taxable income.
- You can build up your Roth IRA balances to create more flexibility in your future retirement “paychecks.” Having larger Roth retirement balances means you can tap that income with no income tax ever. Your Roth accounts can then become perfect emergency or splurge accounts.
- You may even be eligible for Obamacare tax credits before you qualify for Medicare at age 65. Yes, this is a possibility as long as your income remains under 400% of the federal poverty level for your household size.
Now, even if you don’t retire early in your 60s, you still have opportunities. They may be over a shorter period, but you can still structure your accounts and income to pay a bit more in taxes now to avoid paying more in the future. (For related reading, see: Not All Retirement Accounts Should Be Tax-Deferred.)
Yes, there are a lot of moving pieces to consider, but opportunities abound if you know how the pieces fit together. That’s what makes this 10-year period so challenging and interesting. And it is a chance you may never get again during your lifetime.
Now, a word of disclaimer: Keep in mind that tax laws change, tax brackets change, and assumptions about the future are just that—assumptions. The challenge is to take advantage of the tax-planning opportunities available in the short to medium term without betting your entire strategy on assumptions that may change in the long term. (For related reading, see: 5 Tax(ing) Retirement Mistakes.)