Retirees’ Tax Puzzle: Pay Now or Later?

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The majority of retirees pay no federal taxes. But taxes should be a concern for retirees who have retirement savings. That’s because the money they take out of their retirement accounts for living expenses will be treated as federal taxable income. It’s difficult enough to figure out how much money to withdraw – and when. Taxes are a separate but related issue.  

In this blog, we interviewed Michael Kitces, a well-known financial adviser and partner with a Maryland financial firm, who writes the “Nerd’s Eye View” blog. He discusses the basics of navigating the tax code. The challenge facing retirees is to make tax decisions today that will minimize taxes now and in the future.

Question: Do you find that new retirees are surprised by their retirement tax situation?  

Kitces: It’s usually not even on their radar screen. Pre-tax and post-tax income, different tax buckets – I don’t think most people even think about it once they’re in retirement. That’s why we’re still seeing people who are “surprised” when they turn 70½ and the required minimum distributions (RMDs) begin, and their tax bill gets a whole lot higher. They say, “Why didn’t we plan for this?” We say, “We’ve been recommending you plan for this for years!”

The reality is that while we’re working, we don’t think about taxes a lot – the first time you get your paycheck, you notice the difference between what your boss said you were going to get paid and what you take home. You get over that and then work for 40 years, and you just get used to your after-tax cash flow and lifestyle. But when you get into retirement, you have to think about whether accounts are pretax (traditional 401(k)s and IRAs) or after tax (regular bank accounts) or tax free (Roths), and how to draw them down. There’s nothing natural about it.

Q: You said the top income is $75,300 for married couples who want to remain inside the 15 percent tax bracket, after taking all deductions and exemptions. Isn’t that a fairly high dollar threshold that leaves many retirees in this relatively low tax bracket?

Kitces: Yes. And the added benefit is that if your ordinary income is that low, your federal capital gains rate on investment sales from your taxable accounts is zero.

Q: You say that the goal of retirement tax planning is fairly simple: to stay below that 15 percent threshold if at all possible?

Kitces: Yes. The trouble that people get themselves into is that they may have a traditional IRA or 401(k), and they let it sit for a while and they spend their other regular taxable savings and investment accounts first. Then they turn 70½ and the RMDs begin. Stacking RMDs on top of their Social Security and other income sources knocks many people over the 15 percent tax threshold.

Those in the higher tax brackets face a similar problem. They may be in the 25 percent bracket, and should try to stay there, but if they let the IRA grow tax-deferred too long, the RMDs can push them up to 28 percent or 33 percent tax rates.

Q: Some retirees are able to save both in regular bank accounts and mutual funds and in tax-deferred traditional 401ks and IRAs? What is the conventional wisdom about drawing down different types of accounts?

Kitces: The conventional wisdom is straightforward. IRAs are tax-deferred. Let tax-deferred accounts sit as long as possible and let compounding growth happen, and spend everything else first. That’s it.

Q: How can the conventional wisdom get some retirees into trouble?

Kitces: If you get to the point where, either due to your spending needs or your RMD, so much money is coming out of your traditional IRAs or 401(k)s, it can push you up into the next tax bracket. The good news is you’ve paid your tax bill later. The bad news is you’ll pay more in taxes because you drove your tax rate up.

It’s good to have tax-deferred growth, but there really is such a thing as being “too good” at tax deferral.

Q: So, retirees should think about whether it makes sense to pay more taxes now to avoid paying a lot more taxes later?

Kitces: Yes. Ultimately, smooth out your tax rate over your lifetime. Paying a lower tax rate now, but causing a much higher tax rate later when the RMD kicks in can result in less total retirement income and wealth over your lifetime.

Q: How can retirees keep their income – wherever it comes from – within the lowest 15 percent tax bracket as long as possible?

Kitces: The simplest way to do this is to take part of your annual spending from your IRA, which causes a tax bill, but only a modest amount that still keeps you in the same 15 percent tax bracket.

The more complicated way to do this is to keep spending from the taxable account first, but instead of taking money out of your traditional IRA to fill up your low tax bracket, do a partial conversion of that IRA to a Roth IRA, to the extent that the taxable income on the conversion does not push you out of the 15 percent tax bracket.

Q: Let’s stop here. Isn’t everybody different when it comes to taxes?  

Kitces: This framework – spend the taxable accounts first, but don’t let the unused portion of the low tax brackets go to waste – is fairly consistent across the board, whether the client’s retirement income is $300,000 or $60,000. 

Q: What should middle-income retirees with relatively small 401(k)s do?

Kitces: One of the best ways to generate retirement income in low brackets is actually to find anything that is up [in value] in the investment accounts and create capital gains for yourself – because the capital gains get a federal tax rate of 0 percent. You may pay a tiny bit for state income tax liability, but the 0 percent federal capital gains tax rate is about the best deal you’ll ever see. You might as well harvest the biggest gain possible and reduce your capital gains exposure in the future. Even if you don’t need the money, you may still want to harvest the capital gain to take advantage of this.

There are two wrinkles: harvesting capital gains is a great deal for lower-income retirees, but all of your income after deductions, including the capital gain itself, has to fall under the $75,300 threshold.

The second thing you have to watch out for is the taxation of Social Security benefits. Initially, you may think you’re in the 15 percent bracket, but if you’re phasing in the taxation of your Social Security benefits, that bracket could go to 22 percent or even 28 percent. Those initially in the 25 percent bracket may find that their marginal tax rate has increased to almost 46 percent when Social Security taxes are phased in.

Q: Would everyone agree with your strategy?

Kitces: None of this is controversial as a framework. Timing and executing it can be more complex, and that varies by the individual and their assumptions about their future tax rates and time horizons.

Q: But none of this matters for retirees who have virtually nothing saved and are living primarily on Social Security, perhaps bringing in a bit of part-time income. Correct?

Kitces: Correct. If you have no investment assets or retirement accounts, there’s not much need to optimize the taxation of those assets and your income.

Q: What should new retirees know about the RMDs lurking in their future?

Kitces: It can be a big whammy if you’re not watching for it in advance.

For a lot of people it turns out not to be an issue, because their income doesn’t cross the threshold into the next tax bracket.

But sometimes it does. What we see from a lot of people, even with fairly moderate IRAs, is that they forget how much that account can grow through your 60s and into your 70s if it’s invested, especially if you’re trying not to use it.   What seems like not that huge an account can turn into a big account with some sizable RMDs later.


Your blog keeps getting better and better. Excellent interview, loaded with info.

Joel L Frank


A great explanation!


Joel L. Frank

    Joel L Frank

    Also, there are all too many DC plans that do not offer a Roth feature and if they do many of them do not offer an in-plan Roth conversion program.


Mark Zoril

Great post, Kim! Michael is a wonderful source of information for both advisers and the public.

Chuck Miller

More and more people are going to work later regardless of whether they need Social Security income or not. What would happen to your tax situation if 1) you worked until age 70 and 2) you deferred Social Security until age 70?

Kim Blanton

As always, readers are eager to talk about retirement taxes, and it’s not even April yet.
These comments and others on Twitter are giving me ideas for future blogs on tax issues such as working and delaying Social Security to 70 and how deferred annuities might fit in.
Thanks much!
Kim (blogger)


This is a great post. I printed it up for future reference. Keep these types of posts coming!

C barry

Great strategy. However, most people wait until April to think about taxes. I have used this tax strategy the last few years paying $500 on $110k last year. Don’t see the Trump tax reform getting much better than that.

Nancy Webman

Very informative

Ex-Salesman Mike

As an early retiree who had calculated to live off non-retirement savings for a number of years before claiming pension and Social Security benefits, my wife and I have been able to convert roughly $40,000 per year of taxable traditional IRA retirement savings into non-taxable Roth IRA accounts with no adverse tax consequences, merely declaring it as income against our itemized deductions and personal exemptions.

James Gunden

This article is very helpful. Well written, with facts and enough context to understand the concepts. The $75,300 number is very important. I’m in first year of full retirement and drew capital gains as part of my income. I was surprised and couldn’t figure out how my 2016 federal tax liability could be so low. Now I know why. Thank you!

T Morris

When we turned 62 I looked ahead and realized that our traditional IRAs were a tax time bomb, so we decided to take our SS benefits early solely to cover the taxes due on converting our IRAs to Roths over time. We completed the process after eight years of partial conversions. Now we enjoy our SS benefits and foresee having simplified investing choices and only minimal income taxes for the rest of our lives.

Jan Hoistad

I am single, age 61, currently taking taxable 401(k) distributions of $3000/month. Just enough to keep me in the 25% bracket. Can I convert two months of distributions ($6000) to a Roth IRA, if I do it within 60 days? Does the 60 day rule even apply? I will never be below 25%, so I’m trying to reduce future RMDs. If I can convert to my Roth IRA, it’s worth paying some taxes now.

    Michael Kitces

    Yes, technically you have 60 days to do a rollover of a distribution, and you could roll it over to a Roth instead of a traditional IRA (which would effectively be a Roth conversion). Bear in mind, though, that if the money isn’t converted directly and is taken as a distribution first, you can only do a 60-day rollover once in a 12-month period (see In addition, any money that is taken as a Required Minimum Distribution CANNOT be rolled over (or Roth converted) at all.

    Jan’s question is actually dealing with two completely unrelated rules:
    #1 – Roth conversion must be done by December 31st. Period.
    #2 – If you take money out of an IRA, and want to PUT IT BACK, you can do so, but only within 60 days, and only once per 12 months.

    Bear in mind that MOST Roth conversions are NOT done with version #2 at all. The money is simply transferred DIRECTLY from the IRA to the Roth IRA. The 60-day rule and once-per-12-month rule are an additional complication that occurs because the person is trying to UNDO a distribution that has ALREADY occurred (and make it a Roth conversion), rather than just doing the simpler direct Roth conversion in the first place.

      Jan Hoistad

      Thank you for your response. The TSP has very limited withdrawal options. A direct transfer from the TSP to an IRA (traditional or Roth) on an annual basis is not an option. So I’m taking monthly payments. I once read that our 60s could be called the “sweet spot” for early retirees, a window of opportunity between 59 1/2 and the RMD, where some tax planning could be done. So, if I’ve got this right, I can convert distributions from my TSP to my Roth IRA once a year, if done within 60 days. This seems like a great way to build up my Roth IRA for these 10 years. Based on the link you sent to an earlier article, does that “once a year” mean “once a calendar year” or “once every 365 days”? I don’t really want to put this on the calendar for every Dec 15. 🙂 Thanks again!

pat harris

Please all when you get a letter from TSP advising that you need to make a decision re: disposition of your account once you reach 70 1/2…READ THE DISTRIBUTION FORM CAREFULLY. I received a large check, taxes withheld. (Not what I wanted & TSP would not let me reverse the transaction) I put that $ in a Roth; at the end of the year when I realized my tax bracket was 33% I recharacterized the Roth to traditional IRA. Unfortunately the Roth account had lost $ so that the tax sheltered amount was far less. So even after recharacterization my taxes were $50K even though I never “saw” the supposed income. Another fallout was my Medicare premium went up 300%. Bottom line: BE CAREFUL.


1. In the first question presented in the story, it says the top income for a married couple is $75,300 who want to remain inside the 15% tax bracket. What is it for single people?

Also, I was under the impression that I would have to pay taxes on all my investments once I started withdrawing from my 401k retirement plan, my 403b voluntary program, and my rollover IRA. I thought the only investment that I would not have to pay taxes on when I received distributions is from my Roth IRA. Are these assumptions correct?

2. The top of the 15% tax bracket for individuals is $37,650 in 2016.

    Michael Kitces

    Regarding retirement accounts, yes any/all pre-tax retirement accounts (IRA, 401k, 403b, etc.) are taxable when distributed. The only question is the tax rate they’re subject (10% bracket, 15%, etc.).

    However, withdrawing from standard investment accounts – e.g., the account that you earmarked as being for “retirement” but it’s simply a normal bank or investment account – is only taxable on the GROWTH, not the BASIS. In other words, withdrawing $100,000 from my IRA is taxable for $100,000. Withdrawing $100,000 from my bank account is not taxable. Liquidating $100,000 of stock in my investment account (that I earmarked for retirement) is not taxable if the cost basis is $100,000 (and even if the cost basis was lower and there is a capital gain, only the capital gain portion is taxable, not all of it).

    The confusion for most people is when they put money into an bank or savings or even investment account, call it something for their “retirement”, but it’s not literally taxed as a PRE-TAX retirement account like an IRA (which is all taxable unless there are non-deductible contributions), it’s NON-taxable unless you have actual GAINS/INCOME earned by the assets (and then only the gains/income are taxable).

Nancy Hockett

My husband and I receive defined pensions totaling $85,000 annually. We have TSP accounts, traditional IRA’s and a small amount in a Roth IRA. Since we have so much room till the next tax bracket, does it make sense to convert our accounts to Roth IRAs? Thank you.

    Kim Blanton

    Yes, your situation is, just as Michael explained it, a classic case of when the tax strategy described in the blog might make sense.
    However, as with any personal financial situation, the specifics of yours may be different in ways I can’t anticipate.
    Thank you Nancy and everyone else for these excellent comments!
    Kim (blog writer)

Jan Hoistad

I understand that distributions from a traditional IRA can be taxed and converted to a Roth IRA. Can the same be done if the distribution is from a 401(k)?

Larry N.

I think 2017 will be our worst tax year ever.

My wife and I are both hitting 70, and, by living frugally, we’ve done a decent, but not great job, of building our (traditional and Roth) IRA and SEP accounts.

So, in 2017, we’ll start receiving Social Security — roughly $37,000 for me and $15,000 for her — and I’ve got a pension of $13,000 a year. My quick calculations indicate that I’ll have to take an RMD of about $20,000 from my SEP and IRA, and my wife will have to take out about $10,000. And we’re both still working (self-employed) because we like what we’re doing.

If I’m reading this article correctly, these numbers total well above the $73,500 cap on the 15 percent bracket, so it looks like, from all sources, our retirement income will be greater than what we’ve ever earned in a single year — and that doesn’t count what we will earn in 2017.

I’m sure we’ll work another 3-5 years — and put what we can into Roths or taxable mutual fund accounts, but it sure looks like we’ll be in the 25 percent bracket that we’ve avoided for all but one or two years of our working lives.

Any suggestions?

Kim Blanton

Since this blog attracted a lot of interest – tax stories usually do – I want to relay the notion of “marginal tax rates,” which Michael Kitces mentioned to me in an email after the blog ran.
Michael said, “[T]he amount that’s over the threshold is subject to 25%. The income up to that point is still taxed at 10% and 15% rates.”
Thanks for everyone’s input!
Kim (blog writer)

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