By: Aristata Financial

Retirement changes more than where your income comes from. It can completely change the way your income is taxed. Consider someone who retires at 62 or 65. Their salary disappears, potentially causing taxable income to fall significantly. They may not have filed for Social Security yet, and required minimum distributions (RMDs) could still be years away. For a period of time, they may find themselves in one of the lowest tax brackets they’ve experienced in decades.

That window won’t stay open forever. Social Security eventually begins, Medicare introduces another set of income-related considerations, and RMDs eventually force money out of traditional retirement accounts. Add investment income, pensions, or other sources of income, and someone’s tax situation could look very different later in retirement. That’s why some of the most important tax decisions in retirement can happen during the first few years.

The Years Between Your Last Paycheck and RMDs

The period after retirement but before RMDs begin can create an unusual amount of flexibility. Without wages or mandatory retirement account distributions filling up the tax brackets, retirees may have more control over how much taxable income they recognize each year. That creates an opportunity to consider Roth conversions, intentionally realizing capital gains, charitable giving, and which accounts should fund spending.

For example, taking $80,000 from a traditional IRA when you only need $50,000 to fund your lifestyle might initially seem counterintuitive. Why voluntarily recognize an additional $30,000 of taxable income? Depending on the circumstances, paying some tax today could reduce the size of the traditional IRA, lower future RMDs, and create more flexibility later in retirement. The goal isn’t necessarily to pay the least amount of tax this year. It’s to evaluate what today’s decision could mean over the next 10, 20, or 30 years.

Social Security Is More Than an Income Decision

When to file for Social Security is another important part of the equation. It’s easy to compare claiming at 62, full retirement age, or 70 based primarily on the size of the monthly benefit, but changing the filing date can affect other parts of the financial plan as well.

In our planning process, we take a deeper look at different Social Security filing strategies within the context of the entire financial plan. If you delay Social Security, how much more will need to come from the portfolio in the meantime? Could delaying benefits create additional years for Roth conversions while taxable income is relatively low? How does each strategy affect taxes later in retirement, and what happens if one spouse significantly outlives the other? Social Security shouldn’t be evaluated in isolation because changing when you file can create ripple effects throughout the rest of the plan.

Medicare Adds Another Layer

Once Medicare enters the picture, income decisions can become even more interconnected. Higher income can potentially trigger Income-Related Monthly Adjustment Amounts, or IRMAA, which increase Medicare Part B and Part D premiums. Because IRMAA generally looks back at income from two years prior, a tax decision made today could affect Medicare costs later.

That doesn’t necessarily mean additional taxable income should be avoided. A Roth conversion that results in higher Medicare premiums, for example, could still make sense if it produces a better long-term outcome. It simply means the additional Medicare cost should be included when evaluating the decision rather than discovered after the fact.

Creating Options Across Three Tax Buckets

One of the most valuable positions to have entering retirement is money available across three different tax buckets: taxable, tax-deferred, and tax-free. Each gives you a different way to fund your lifestyle and manage taxable income.

Taxable accounts may offer preferential capital gains treatment, while traditional retirement accounts create taxable income when withdrawn. Roth accounts can provide tax-free qualified withdrawals. Holding money across all three gives retirees more control over their spending and taxable income.

That flexibility becomes especially valuable when you’re trying to manage several decisions at once. One year, you may want to realize capital gains while you’re in a lower tax bracket. Another year, you may want to convert part of an IRA to Roth. You might use qualified charitable distributions later in retirement or draw from a Roth account to fund a large purchase without creating additional taxable income. The more options you have, the more control you may have over how these decisions interact.

Think Beyond This Year’s Tax Return

Retirement tax planning shouldn’t be a series of isolated decisions made one year at a time. Minimizing this year’s tax bill can feel like a win, but it isn’t necessarily the best long-term strategy if it means allowing a large tax-deferred account to continue growing until RMDs eventually push taxable income higher.

A better question is, “How does this decision affect the taxes I may pay over the rest of my life?” Sometimes the answer may be to recognize income sooner, and other times it may be better to defer it. There may even be years when intentionally paying more in taxes today creates a better outcome over the course of retirement.

The first years of retirement can provide a unique window to make those decisions while you still have significant control over your taxable income. Good retirement tax planning is about recognizing that window, understanding how the different pieces of your financial life interact, and using the flexibility you have today to create more options for the years ahead.

Any opinions are those of Aristata Financial and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Prior to making an investment decision, please consult with your financial advisor about your individual situation.

Contributions to a traditional IRA may be tax-deductible depending on the taxpayer’s income, tax-filing status, and other factors. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 591/2, may be subject to a 10% federal tax penalty.

RMD’s are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation.