4 Steps to Achieve Consistent and Tax-Efficient Retirement Income Planning
Surprises are not a good thing when it comes to your finances. Unfortunately, a lack of retirement income planning can set you up for potential spikes in income that could result in higher-than-necessary taxes. Here are 4 steps to help ensure a smooth and tax-efficient flow of income in retirement.
1. Watch Out for the RMD Effect
Over the course of your career, you likely have been saving diligently into one or more tax-deferred retirement plans. Of course, tax-deferred is not the same as tax-free. A deferral of tax is just that — a delay. When you reach the age of required minimum distributions (RMDs), those amounts can cause your taxable income to spike, moving you into a higher tax bracket.
RMDs apply to original account holders and their beneficiaries in the following types of plans:
- Traditional IRAs
- SEP IRAs
- SIMPLE IRAs
- 401(k) plans
- 403(b) plans
- 457(b) plans
- Profit sharing plans
- Other defined contribution plans
- Beneficiaries of Roth IRAs
If you have money in one or more of these types of accounts, then the current rule is that you must start taking RMDs the year you turn 73 (although you can delay the initial year withdrawal until April 1 of the following year). The IRS calculates RMDs by dividing your account balance as of the end of the immediately preceding calendar year by a life expectancy factor (See Publication 590-B).
Consider this scenario: Alice and her husband have been living off of Social Security and post-tax savings since they both retired. Alice hasn’t touched any of the money in her tax-deferred IRA, which has reached a total of $4 million in assets. She turns 73 in 2025, which means she must start withdrawing from the account. Based on her life expectancy factor, her RMDs will be roughly $151,000 per year, bumping her and her husband from the 12% to the 24% federal tax bracket. Not only do they have more taxable income, but the tax bracket also increased significantly.
Another wrinkle awaits higher-income taxpayers: They may have to pay more in Medicare premiums. The Social Security Administration uses the modified adjusted gross income (MAGI) from your most recent federal tax return to determine the percentage of the Medicare premium amount you pay. For example, married couples with MAGI above $212,000 pay an additional premium for Medicare Part B and prescription drug coverage.
2. Fill Up Tax Brackets to Smooth Out Taxable Income
One way retirement income planning can help avoid peaks and valleys in taxable income is by accelerating some taxable income in the years leading up to the age when you’re subject to RMDs (age 73).
In the scenario above, consider if Alice started taking distributions from her IRA at age 68. The idea is to withdraw just enough to “fill up” the current tax bracket without pushing the taxpayers into the next bracket. Since they don’t need the funds immediately, they can roll them into a ROTH IRA or another brokerage account, allowing the funds to continue to grow. They could also each give up to $19,000 per taxpayer to each of their kids, in-laws, and grandkids, thanks to the annual gift tax exclusion.
By the time Alice turned 73, those RMDs would have been more manageable and less likely to push the couple into a higher tax bracket. Over the course of those five years, smoothing out their income from year to year likely would have resulted in lower taxes overall, and possibly keeping them in a lower tax bracket into the future.
3. Already 73? Take Advantage of Qualified Charitable Distributions (QCDs)
For taxpayers who are already 73 or older, another tax strategy can help reduce taxable income. Individuals who are required to take RMDs can transfer money directly from their IRAs to a 501(c)(3) charity (or charities) of their choice. These qualified charitable distributions (QCDs) count toward the taxpayer’s RMD for the year, and they will never be counted as taxable income on the federal income tax return. The QCD limit is indexed for inflation, so in 2025 taxpayers can make tax-free contributions up to $108,000.
The QCD is a natural choice for high-income retirees who are 73 or older and want to give to charities. If you don’t itemize, you can use the QCD in addition to the standard deduction (more than $30,000 for married couples in 2025). And if you do itemize, your QCD is counted separately from your other itemized deduction. But remember: These tax advantages are only available if the money is transferred directly from the IRA to the charity.
4. Model Different Retirement Income Structures
Whether you’re 55 and planning ahead for retirement or you’re 73 and looking to manage the effects of potentially burdensome RMDs, it’s never too early or too late for retirement income planning. Just remember that tax laws are always subject to change. Keep in mind that the current historically low tax rates and high estate tax exclusion are slated to expire at the end of 2025. So, it’s best to act soon.
Reach out to your tax advisor for holistic and tax-efficient retirement income planning for you and your family. Your tax advisor will be able to model different scenarios, such as accelerating distributions from pre-tax retirement vehicles or taking advantage of QCDs, to design a plan to lower your overall tax liability in retirement.