How can I use a low income year to my advantage?
I have the option of largely living off my savings for the 1st year (or 2) of my retirement. My annual income will be limited to $9,000 gross from an annuity, and around $1,200 from a small brokerage account. What moves should I make in this low income bracket year? Should I be harvesting my capital gains (tax free?) from the brokerage account?
Congratulations on making it to retirement! We hope you are positioned well enough to love your retirement years.
This question is an excellent one that may present you with a good opportunity to take advantage of certain strategies you would not ordinarilly be in a position to use.
I would preface this answer by saying, it is very important that you consult with your or find a fiduciary advisor to guide you. This advisor will also need to coordinate efforts with your tax advisor. Decisions like these should be made hand in hand with these two members of your financial team.
You may be able to utilize some of the following strategies:
1) Capture capital gains in positions with low basis
2) Converting IRA assets to a Roth IRA
3) Removing assets from assets that would produce ordinary income tax
These are the top three strategic moves you may want to consider. I would make sure that you consult with your team and find out what will be the best strategies for you.
Best of luck as you enter this next stage of your life and enjoy.
You should consider a tactical Roth conversion of any traditional IRA or Employer sponsored retirement accounts you may have. Typically, after you determine what your tax bill will look like for the current year you can make the decision to convert a portion of your traditional retirement accounts to Roth. This allows you to control the rate you will pay taxes on those dollars. Additionally, you will be reducing the size of your required minimum distribution at age 70 ½ since there are no RMDs from Roth accounts. The dollars you convert can continue to grow tax-free inside of your account to be available for you later in your retirement or be used as a great vehicle to move wealth down to the next generation. Good luck!
You do have a couple of strategies that can be exploited during this "doughnut hole" of income early in your retirement. I assume that you are deferring social security benefits until age 70. Required minimum distributions from your qualified retirement plans do not commence until the year after you turn 70 1/2.
Yes, harvesting capital gains from your taxable account can be a helpful strategy. Assuming you are married, your long term capital gains tax rate is 0% for taxable income up to about $76,000 (about half that if you are single). You should be able to sell off some highly appreciated assets after you separate from your employer.
You might also consider executing a Roth conversion for some of your conventional IRAs and 401ks. A married couple filing jointly pays tax at a 15% rate on income up to $76,000. That rate increases to 25% at income levels from $76,000 to $152,000. Why not pay some taxes in early retirement, while the couple's tax burden is relatively low. For more details, take a look at my article on Roth conversions.
Both capital gains harvesting and Roth conversions confer tax benefits to early retirees with incomes that are otherwise low. I might consider the Roth conversion first if you haven't yet accumulated any Roth assets. Having substantial tax-free assets later in life will provide you with emergency cash reserves from which you can take distributions without bumping your tax bracket.
In principle, these strategies allow you to take advantage of low tax rates before social security benefits and RMDs kick in later in life. You are taking the right approach.