One of the biggest benefits of retirement is that probably for the first time in years, you can get full control over your time. If you prefer spending the afternoon watching Bonanza over and over again, no one can stop you.

On top of that, retirement also offers you more control over your money. While you are working, you have a very limited control over how often or how much you pay, which also limits your ability to lower your taxes.

However, if you are drawing retirement income from a combination of different types of accounts, you might be able to control the amount you ultimately withdraw, and also the sources of the respective withdrawals.

Ultimately, that can have a great impact on your taxes now and in the future, as well. Conventional wisdom dictated for a long time that retirees should take money from their taxable brokerage accounts first, then the traditional IRAs and other tax-deferred accounts, with Roth IRAs and Roth 401(k)s coming last.

The logic behind this way of thinking is that it buys more time for your tax-advantaged accounts. Money in tax-deferred accounts isn’t exactly taxed until you actually take withdrawals, and withdrawals from a Roth are totally tax-free as long as you are 59 and a half years older, and you’ve owned an account for a minimum of five years.

What has changed?

Well, in the most recent years, some retirement experts seemed to have questioned whether this is actually the most effective way to lower your taxes on your retirement income and preserve your savings for your later years.

Postponing withdrawals from your tax-deferred accounts might eventually lead to large, taxable required minimum distributions RMDs currently start at 73 years. Since these withdrawals are now taxed at ordinary income tax rates, which can range from 10% to 37%, larger distributions might push you into a higher tax bracket and even trigger Medicare high-income surcharges.

Roger Young, a well-known certified financial planner and a thought leadership director for T. Rowe Price agrees to this idea. The conventional withdrawal sequence basically “bunches a lot of taxable income in the middle period, where pretty much all the income is totally taxable.”

Retirees who have more than one account might generate income more tax-efficiently by simply withdrawing from a combination of taxable and tax-deferred accounts, but also as making strategic conversions to Roth accounts, while also staying in a low tax bracket.

One way in which you can accomplish this goal is to withdraw enough from your taxable accounts and cover spending needs and income taxes. After that, you can calculate how much you can withdraw from your tax-deferred accounts and convert to a Roth while also staying within your desired tax bracket.

In 2024, a married couple who decides to file jointly can get as much as $94,300 in taxable income and fall within the 12% tax bracket. As for singles, the cutoff is $47,150.

These thresholds are generally close to the points at which taxpayers would be able to qualify for a 0% tax rate on long-term capital gains and also qualified dividends (assets that are generally held for over a year are also subject to rates for long-term gains).

This year, the 0% rate applies to capital gains and also qualified dividends for singles with taxable income as high as $47,025 and married couples with joint taxable income of up to $94,050.

Well, taking strategic withdrawals from a wide mix of taxable and tax-deferred accounts while also staying within these thresholds comes with two benefits. You might pay taxes on your tax-deferred withdrawals at a much lower rate, and also reduce the size of those accounts, which could also shrink your RMDs. You can also qualify for the 0% capital gains rate on income from the taxable accounts.

On the meantime, you might pay taxes on conversions from a traditional IRA to a Roth at a much lower rate, which could also increase the amount of tax-free income you would have on hand in later years. Ideally, you can use assets from your brokerage or other taxable accounts to pay the taxes on the conversions.

However, if you postpone your Roth conversions until you’ve totally depleted those accounts, you might have to use the funds from your IRA to pay the tax bill. That’s not really the end of the world, especially since you will still benefit from having future tax-free income. However, it does reduce the amount of money you would be able to invest in the Roth.

Taxes on Social Security

Converting your funds in your traditional IRAs to a Roth can also help reduce your taxable income much later in life. Ideally, a huge percentage of your withdrawals can come from your Roth. This will also help you avoid what Pfau calls the Social Security “tax torpedo”, which generally happens when up to 85% of your benefits are taxed.

The ideal formula for calculating tax on Social Security benefits is mainly based on what Social Security defines as your provisional income (sometimes, it can be referred to as combined income), which is mainly based on half of your Social Security benefits, and other sources that could contribute to your adjusted gross income, such as withdrawals from traditional tax-deferred accounts.

To all that, make sure you all add dividends, interest, capital gains from taxable investment accounts, and also interest from municipal bonds.

Charitable giving

In case you plan to offer funds in your tax-deferred accounts to charity, you might not need to accelerate some withdrawals as much as you would otherwise. One strategy that could potentially reduce your RMDs, and your tax bill, is to make a qualified charitable distribution, which is basically donations made directly from your IRA to qualified charities.

You can also make a QCD as early as 70 and a half, but when you reach the age at which you are required to take distributions, the charitable distribution might count toward your RMD. Even if a QCD isn’t deductible, it could reduce your adjusted gross income, which will in turn reduce the provisional income needed to calculate taxes on your Social Security benefits.

In 2024, you are able to donate up to $105,000 directly from your IRA to a qualified charity. At the same time, if you are worried about giving away money you could use for long-term care or any other late-in-life expenses, you can also leave funds in your IRA to charity. The charity won’t pay any taxes on the money, and you will be able to leave more tax-friendly assets to your kids and grandkids.

Your estate and taxes

Shifting a huge chunk of your assets to Roth accounts won’t simply lower your taxes later on. It could also benefit your grandkids, especially if they end up inheriting money in any of those accounts.

Under the SECURE Act of 2019, the wide majority of adult children and other non-spouse heirs who automatically inherit a traditional IRA or any other tax-deferred account from an owner who died after January 2020 are presented with two options:

• take a lump sum and pay the taxes on the entire amount
• transfer it to an inherited IRA and deplete the account in the next 10 years since the death of the original owner

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