Investor Toolkit

Here's how to maximize those retirement 'sweet spot' years

Key Points
  • When full-time work is behind you and distributions from your retirement accounts are ahead of you, there's a good chance you are in a lower tax bracket.
  • Converting your traditional IRA or 401(k) to a Roth IRA can make sense if you have the cash to pay the taxes due on the conversion.
  • It also can be an ideal time to unload assets with long-term gains.
Gerald French | Getty Images

As you head into retirement, there's a chance you also are entering a special time to do some serious tax planning.

This sweet spot is the stretch of time between when you retire from full-time work and when you have to start taking required minimum distributions from your 401(k) plan or your traditional individual retirement account at age 70½.

Presumably, given that full-time work is behind you and those mandated distributions are ahead of you, it's also when you find yourself in a lower tax bracket.

Photo by Ariel Skelley via Getty Images

"This is a good time to look at whether some strategies can work that help with taxes," said Avani Ramnani, director of financial planning and wealth management at Francis Financial.

While there are ways to take advantage of lower tax rates, it's important to make sure any moves you make are in line with your broader retirement goals.

"Minimizing taxes should not dictate all financial decisions," Ramnani said. "Ultimately, it is about using the best approach to be able to achieve [your] most important life goals."

Here are some ways you might be able to capitalize on your lower tax bracket.

Go Roth

It could make sense to convert a traditional IRA or a 401(k) plan account to a Roth IRA.

While you must pay income taxes on the amount converted, it would be at your temporarily lower rate.

In comparison, if you were to leave those assets in a traditional IRA or 401(k) plan and not touch them until you begin taking required minimum distributions, those withdrawals could push you into a higher tax bracket. As such, a higher tax rate would apply to the assets.

Plan for health care in retirement

In contrast, withdrawals from Roth IRAs are generally tax-free. There also are no required minimum distributions that come with them. In fact, some people simply let the balances accumulate over their lifetime and pass the Roth IRA on to heirs (who also enjoy the tax-free status, although they must meet other rules).

You also can stretch a conversion to a Roth IRA over several years, which can minimize the tax sting and can help ensure the switch doesn't push you into a higher tax bracket in any given year.

However, before you get the wheels rolling, there are some aspects of the conversion to consider.

For starters, you need to make sure you have enough cash available to pay the taxes due.

Also, new tax rules that took effect this year eliminate the option to change your mind for conversion done in 2018 or later.

"If you do the conversion, you're locked in," Ramnani said.

Additionally, the Roth IRA generally must remain untapped for at least five years after the conversion for you to take advantage of completely tax-free withdrawals.

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Sell winning assets

If you have any stock or other asset in a taxable account, it's worth looking at whether it would make sense to sell off appreciated long-term investments while you're in a lower tax bracket.

"It's a great opportunity to cash in on gains that you've been sitting on," Ramnani said.

This is because the tax rate on long-term capital gains — those on assets held beyond one year — is based on your adjusted gross income (see below chart). For instance, if a married couple has income under $77,200, they will pay no tax on those gains.

What you pay on long-term capital gains

Tax rate Single taxpayers Married filing jointly Head of household
0%Up to $38,600Up to $77,200Up to $51,700
20%Over $425,800Over $479,000Over $452,400
Extra 3.8%Over $200,000Over $250,000Over $200,000

If you were to wait to sell those appreciated assets at a time when your income is above the threshold for the zero percent rate, you will pay either 15 percent or 20 percent.

Be aware, too, that high earners — i.e., married couples with modified adjusted gross income above $250,000 — are subject to an additional 3.8 percent tax on certain investment income.

Exercise employee stock options

For people who head into their golden years with employee stock options, exercising those options at your lower tax bracket might be smart.

"If the value of the stock is high and your exercise price is low, you'll have a lot of built-in gains when you exercise those options," Ramnani said. "You could use your lower tax year to exercise some of your options."

Unload savings bonds

While U.S. savings bonds have lost popularity as a means of long-term savings due to the low interest rates they currently earn, some retirees have been holding on to bonds that were issued when rates were higher.

"For some people, we've seen the interest add up to quite a bit," Ramnani said.

When you unload those bonds, you pay ordinary income tax on the interest you earned. So while you're in a lower tax bracket, cashing them in could be a good idea.