The Most Valuable Tax Planning Window in Retirement

In today’s episode, you’ll learn more about:

• Why taxes often increase later in retirement
• Roth conversion opportunities before RMDs
• Capital gains harvesting strategies
• Social Security timing considerations
• Medicare IRMAA planning
• The widow’s tax trap
• Why waiting too long can permanently reduce planning flexibility

Listen Now:

The Smart Take:

Go Inside the Episode: 

0:00 – Intro

1:10 – What was released?

2:50 – The Big Headline

5:13 – Are the headlines wrong?

7:26 – Possible fixes

13:59 – How to plan for this

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The Hosts:

Kevin Kroskey, CFP®, MBA – About – Contact

Tyler Emrick, CFA®, CFP® – About – Contact

Episode Transcript:

Tyler Emrick:

Today, we’re talking about what may be the most valuable tax planning window in retirement. Most people assume their taxes go down once they retire, but for many affluent families, the exact opposite happens. There’s often a period after retirement but before Social Security and required minimum distributions begin, where taxable income may be lower than it will be for the rest of retirement. The question is whether you’re taking advantage of that opportunity before it disappears. We’ll discuss where this window comes from, why it matters, and some of the biggest planning opportunities that may exist during those years. All coming up today, on Retire Smarter.

Walter Storholt:

Welcome back to another episode of Retire Smarter. I’m Walter Storholt, alongside Tyler Emrick, a Chartered Financial Analyst at True Wealth Design, one of the wealth advisors there. Also a CERTIFIED FINANCIAL PLANNER, of course, and he’s going to help us navigate through today’s conversation about taxes. A really important topic for anybody thinking about retirement. And The whole crux of this one, Tyler, is that a lot of people spend a lot of time, effort, and energy trying to save taxes, maybe assuming they’ll automatically be in a lower tax bracket in retirement. And then comes a big surprise where all of a sudden taxes are going up on them when they hit those retirement years, and then that causes frustration and creates financial issues as well.

Tyler Emrick:

Well, how does it make sense, Walt? I mean, come on.

Walter Storholt:

Tell us about this. I’m not working anymore. Why am I paying so many taxes?

Tyler Emrick:

Exactly, right? Hey, you’re used to getting that paycheck, you’re used to maybe being in those higher tax brackets and you’re looking for a little relief come retirement, and boom, maybe it’s not as grandiose as it expects and hey, good old Uncle Sam’s getting his hands in your pockets maybe a little bit more than what you expect, man.

No, absolutely. It comes up for more families than what you would expect, right? That logical assumption, when we start thinking about some of these things such as required minimum distributions, maybe Social Security being taxable, there’s a handful of considerations that we need to keep in mind that, hey, you’re still going to have income and distributions and things like that coming into retirement. And if you don’t plan for it, you could absolutely find your situation being in an exact same taxable situation or maybe even a higher tax bracket if you don’t plan appropriately. So, we want to be thinking about it.

And it’s not that families aren’t thinking about it. I mean, I’ll never forget, Walt, I think I’ve told this story a little bit before, but it’s been a handful of years ago now, but obviously it resonates with me because, hey, it stuck with me. But I’ll never forget I met with this individual. New client meeting, right? Hadn’t worked together, we’re just exploring a relationship. And he had been in retirement for a couple years, thought he was doing a really good job, living retirement the way they want. He’s accumulated a good sum of money.

And when we got to start talking about just his tax situation in prior years and how he’s thinking about it, he almost lit up a little bit because when he pulled out and he’s like, he didn’t really pull out. He’s like, “Hey, I don’t have a tax return. I didn’t have to file a tax return last year. I paid zero in taxes in the last year.” And I’m sitting there going, “Well, I mean, hey, that’s great. Right? Why wouldn’t everybody want to do that? I don’t want to pay Uncle Sam any more than my fair share either.” Right? So I get where he was coming from. But through the course of our conversation, I knew that he had this big retirement account that he had done a wonderful job saving in. And hey, he had worked for over 30 years. We didn’t always have Roth contributions and such, right? So all that money was what we call pre-tax, where when you do pull it out, good old Uncle Sam is going to get his hands on a piece of it.

I could just back into… I’ve seen enough of these now to where I could run in a couple scenarios and say, “Well, hey, you’re not living off of this money. You have other money saved. You’ve done a great job, you haven’t pulled any money out of this retirement plan. Do you think you’re going to need to pull money?” “Nah, I don’t know. I’ll start Social Security a little bit down the road, and if all goes well, that money will just sit and grow.” And I’m like, “Hey, great. Let’s back into the math here a little bit. This account’s going to hopefully keep growing. When you hit RMD age,” at the time it was early 70s, “Hey, you know you’re going to have to pull out roughly 4% of the account balance here.” That’s a big number.

Share the number with him and I was like, “You look at these tax brackets, you pair that with your social security, with a couple other portfolio income that you had coming in,” and he was going to be in the 24, higher tax brackets. So he’s like, “Oh, okay. Well, crap. How do we get around that?” I was like, “Well,” right?

Walter Storholt:

A natural reaction.

Tyler Emrick:

Exactly. I was like, “Well, what we want to do is we want to use these years early on where, hey, you didn’t pay any taxes last year, that’s great, but boy, how much could we have taken out of your retirement account and only paid 10%, 12% or 22%?” All lower-

Walter Storholt:

Versus the 24 or higher-

Tyler Emrick:

… 24 or higher.

Walter Storholt:

… that it may be. Yeah.

Tyler Emrick:

You got it, right? So I think that conversation, I mean, he did all the right things, but when you-

Walter Storholt:

What felt like a win to him was actually in a way a loss.

Tyler Emrick:

A loss, right? Because he’s like, “Oh, a missed opportunity for that last year. Crap. How much could I have pulled out of there and actually paid at a lower tax rate on?” Right? So I mean, I think that gets at the crux of this window that we’re talking about, right? So, what is this window? And he was in it. Are you in it, as you are listening here? And it’s really that window is like at the start of retirement. Okay?

So whenever you retire, early 60s, late 50s, whenever it might be, and then but before you’ve started social security and before your RMDs, required minimum distributions. Again, for those listeners RMDs, that’s hey, your retirement accounts when you have to start pulling money from them, specifically your pre-tax retirement accounts, because the IRS wants to get their hands on a piece of it. Right? So you have forced distributions when those required minimum distributions start. But there’s this window for individuals where, hey, they’re not required to start their social security. You don’t have to retire and immediately kick in that social security. And then of course, you maybe have a number of years before RMDs start. So, how do we utilize that window, right?

Looking back on that individual I was just talking about, he wasn’t taking advantage of those years in this window. So the question becomes is, is like, “Well, how? How can we take a look at it?” And I think as we look back into it and as you start in conversations with your advisor or your family or however you’re looking at your financial plan, what you really got to get a handle on and understanding of is, are you going to be in this camp of your taxes potentially being higher down the road? Well, I mean, there’s a number of reasons why that might happen, right? We’ve mentioned a few. Social security, required minimum distributions, right? But there are others. Maybe you have a pension plan. Well, pension plans aren’t going to come to you tax-free. If you’re getting a monthly payment from it, you’re going to have taxes on that. Other big one is for those individuals that have money that they’ve accumulated outside of retirement accounts, where dividends, interest, capital gains, those are all hitting your tax returns.

So yes, you might not have wages or 1099 income actually flowing through that return, but Walt, there are a host of items, even though you’re in retirement that could hit that tax return and increase your tax liability come down the road.

Walter Storholt:

And that doesn’t even take into account government risk of the rules changing and the brackets just going up naturally, right?

Tyler Emrick:

Oh, sure.

Walter Storholt:

That’s another whole element to it.

Tyler Emrick:

Oh, 100%. I mean, we used to talk about that a ton before the One Big Beautiful Bill, right? Tax rates were set to increase and sunset. That didn’t happen, but boy, you start painting a picture of the US debt, plenty of headlines to go in there. How are we going to maybe fix that?

Walter Storholt:

But perfectly fits into your description of this window of opportunity that got extended, thankfully, but may not be there forever.

Tyler Emrick:

But may not be there forever. No, absolutely, you are 100% correct.

Walter Storholt:

Even though if I’m remembering correctly, we had a good time joking about the permanency of that language that was used in regards to those-

Tyler Emrick:

True.

Walter Storholt:

… right?

Tyler Emrick:

Yeah, permanent until it’s not. So yeah, for those listeners, I’m sure this isn’t news to you, but we probably should expect new tax legislation at some point down the road. Hey, that could not be as favorable as the ones that we’re in now. Right? So it’s this whole idea, Walt, of like, hey, not getting so caught up in the here and now, because it’s so easy, just like the individual we talked about. “Hey, this year, what is my taxes? Did I save? Awesome.” But let’s not lose sight of down the road, what are our best guess? What’s our expectations on what that tax liability might be down the road? And how can we use that to make better decisions in the here and now, right?

And there are a handful of opportunities that really we should be looking at, right? And the first one is probably the one we talk about the most on the podcast here, which would be Roth conversions, right? Simply taking money out of pre-tax retirement accounts, moving them over into a Roth, paying taxes, and you have complete control over that. Right, Walt? We can do a $20,000 Roth conversion. You could do a $50,000 Roth conversion. There is no cap on that amount. So hey, if you plan right, if you are coordinating with your tax professional, if you have a fairly good understanding of what your tax return looks like before these, we can be very specific and very diligent on exactly where do we want that to be, right? So, Roth conversions need to be on the docket and should be on the docket pretty much every year as you’re thinking about your tax planning strategy.

The other one is maybe a little bit more subtle, but when I talk to retirees, one of the big things that they’re on their mind, Walt, is, what are we going to do for healthcare, right? What are we going to do for healthcare? That problem gets solved once you turn 65, but if you retire before 65, that problem is there, right? So a lot of families are going to individual healthcare through Obamacare, or we call it ACA through the Affordable Care Act, ACA, subsidy planning is what I’m mentioning here. So when you pick a healthcare plan, the government has subsidies that are available to you, dependent on your income. Okay? So the higher your income is, the less in those government subsidies that you have. These subsidies are not a small chunk of change, right? 10, 15, $20,000 might be up for grabs depending on how much income hits your tax return.

So, I think that really needs to be on the docket as well saying, “Hey, what access do you have to healthcare?” “Hey, these subsidies are out there. Are you in a situation where you should be managing your income to maximize those?” Because, Walt, we’re getting at a situation to where you’re giving up one or the other, right? You think about Roth conversions, what we’re doing is we’re saying, “Hey, we want to increase your tax liability because we think you’re in a lower tax rate now versus down the road.” Well, the ACA subsidy planning for healthcare, that’s the complete opposite. We’re talking about lowering your income to try to pick up more free money. So, they’re working against each other, right?

So the question becomes and why it makes a financial plan all that much more important is, you’re juggling these competing objectives, right? Which ones do we want to prioritize and in what year do we want to prioritize them? Because it’s not set, right? I like to say good old IRS likes to keep financial planners like me employed, because they make these rules as complicated as they possibly can be, and they make them each year, those decisions based off how much money you need, where are your account balances at, what healthcare plan are you going to be? All factor into that answering that very tough question of, “Well, where should my income be and what do I want to prioritize?”

I had a family that I’ve been working with now for, oh geez, seven, eight years, but when they first started it in retiring, they retired in their late 50s. Great, right? Being able to retire in your late 50s is an amazing accomplishment. They saved tremendously to be able to do that. But one of the biggest issues that retirees have wanting to go that early is, “What are we going to do for healthcare?” Right? And they also had done a great job savings so they had a sizable savings amount inside of their pre-tax retirement account. Competing objectives, right? So it’s like building out that short-term plan for them was so much fun because it was talking about, “Well, if we get money out of your retirement account, that affects the state, that affects your RMDs. But hey, we got healthcare, which plan are we going to use, and is this good? And how much subsidies are going to be,” and what is that right balance on what hits your income and not for them?

They had another little caveat in net unrealized appreciation in their situation, where in UA, I think we did a podcast on that certainly within the last six months where they had some stock inside their 401k and there were some unique things they could do. So there was just a fun situation to work through as we were trying to navigate, “Hey, I’m retired. Where am I going to get money to live off of? Hey, what am I going to pay taxes on and should I pay more or should I pay less than taxes in this year in the grand scheme of what we’re trying to accomplish?” So, fun problems to work through, but unless you have some idea of a plan on where you’re going, Walt, those decisions can be hard to make and hard to work through for sure.

But as we look at those, we talked about Roth conversions, we talked about ACA planning. For those of you individuals that maybe have a sizable amount of money that is in outside of retirement accounts, now we start getting into capital gains harvesting and lost harvesting and some complexities there, all of which I think are very important planning opportunities in this window that we brought up. But on the flip side, Walt, hey, with all the opportunities there’s also some pitfalls and some things that we need to make sure that we’re aware of and keeping in mind.

Probably one of the biggest ones would be Medicare premium, what you could be paying and the IRMAA surcharge, where they actually increase your Part B premium if you make too much money. Right? And that’s going to start for individuals that actually are on the doorstep of Medicare age. You would think that you would start worrying about Medicare planning at 65. Well, there’s actually a two-year look back on income when we start looking at managing for increased Part B premiums for Medicare. So really, once you turn 63, that Medicare planning is really going to be at the forefront of your income planning and how much and how high of Roth conversions do you want to do, or how low do you want to keep your income for those ACA subsidies? So I think that’s a trap that most people don’t start thinking about until they turn 65 because they’re like, “Oh, I’m on Medicare now. Why are they charging me three times the premium that I should be paying? Oh wait, oh, it’s because my income was higher a couple years ago when I was 65.”

Walter Storholt:

This is why you can’t just speed run straight to 65 and then go, “Okay, let’s figure this plan out.” This is why you have to start a little bit earlier, otherwise you’re going to miss these opportunities.

Tyler Emrick:

Oh yeah, 100%. Well, and going back to the plan, we harp on the plan so much, but I feel like it’s so important because I think the other kind of trap that families can get into is like, well, when we’re doing these big, nice, fancy plans and projecting out to the best of our ability what your tax situation looks like and your income and where it’s going to come from and all that good stuff, one of the things that we could lose sight of is like, well, what if some major changes happen. Right?

What if your spouse passes away, right? What happens to your tax situation then? Hey, you might run a nice projection, you’re planning out to the age, mid 90s for both you and your spouse. And you look at that and you go, “Oh, we’re in a tax right now, the same one. All right, maybe we don’t have to get aggressive with our Roth conversions.” Well, if we’re not testing out, well, what happens if your spouse passes away earlier, those tax brackets get cut in half, and now your spouse is paying a lot higher taxes than what you expected. Your spouse is now in those Medicare IRMAA limits and over them because RMDs aren’t going away, your spouse is going to inherit those accounts from you. So, understanding that and testing out some of those unique scenarios, I feel like is maybe sometimes a lost opportunity for some individuals that aren’t working with planners that are really leaning on those plan first financial principles.

That goes also with saying estate planning and understanding and thinking through, where are these assets going to eventually land? Are we in a really good financial situation and being able to accomplish everything that we want to in retirement? That’s awesome. Should we start shifting our thoughts to your heirs and what that estate looks like and start making some of these tax decisions based off them, if there’s a substantial gap in their income versus yours and so on and so forth. Right? Because it can very much turn into a conversation and should in a lot of cases turn into a conversation of, “How’s the family doing? How’s the family wealth? How are we protecting our legacy and what’s going down to the family members that are eventually going to inherit some of these assets? So you’re not leaving them with these sizable tax bombs that might just blow up into their face, right?”

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Walter Storholt:

Yeah, yeah. You see these opportunities and you start talking about, how can we save money on ACA subsidies and how are we going to fund healthcare. And all of a sudden, you could go the entire opposite direction and pay three times the premium that you should be paying for Medicare all of a sudden. So, this scale is very interesting to look at and I’m sure makes things fun for you as a planner, a little bit more stressful maybe for us who are having the plan done for us here, Tyler.

Tyler Emrick:

Well, hey, no, it’s the best, right? This window that we’re referring to is probably one of the funnest and most opportunistic times of your financial life to take advantage of all these levers and talking through this complexity. As our job as financial advisors, is to really like synthesize some of these big levers down into concepts and help make it understandable to where you can make some actionable decisions on it. Right? I always say, you don’t have to make the financially maximizing decision every single time, right? But you want to understand those levers. You want to understand what you’re giving up and why you’re doing it, so that way you can just make the best decision for you, your family, and what you’re trying to accomplish. I mean, you did a wonderful job building up that wealth, hey, being a good preserver and trying to protect it and just make good decisions of it, just make that go a lot longer and I think just provide better outcomes in general.

Walter Storholt:

Yeah. Being good at offense is great during your working years and as you’re building up and you want to buff up on your defense when you get into retirement.

Tyler Emrick:

You got it.

Walter Storholt:

It’s an easy concept to start to wrap your brain around, especially when you see all these windows of opportunity and areas of extra planning that can be done, all of that good stuff.

So, if you’ve not done this type of planning before and you’re sitting there with the sizable account that you’ve spent so hard building up and working to create throughout your years of working and with your family, now’s the time to put together that plan, especially the closer you get to retirement. Hopefully today drove home that urgency, that you don’t want to wait just until retirement date to say, “Okay, now let’s do a plan.” Start talking about these things years ahead of when you retire, and you’re going to have that many more opportunities to save money, make more money, and do it as efficiently as possible. Because especially when we talk about taxes, Tyler, if you don’t have a plan, Uncle Sam has one for you, and it may not be what’s in your best interest from an efficiency and money saving standpoint. So, be proactive and you make the decision so that you can maximize your situation.

Book a discovery call with Tyler and an experienced wealth advisor on the team there at True Wealth Design by just clicking the link that’s in the description of today’s show, or go to truewealthdesign.com and click the Let’s Talk button. And again, that’s a 20-minute discovery call. You’re just seeing if you’re a good fit to work with one another, some early conversations about your plan, where some gaps might be, and how the team might be able to help and what that relationship looks like from there. Anybody can sign up and go through that discovery call. Again, click the link in the description of today’s show or go to truewealthdesign.com.

Tyler, thanks so much. Appreciate your guidance on the tax conversation today. We’ll catch up soon.

Tyler Emrick:

Absolutely. Catch you on the next one.

Walter Storholt:

All right. We’ll see everybody again right back here on Retire Smarter.

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