Why Your Tax Bill Going Up Might Be a Good Thing

For pre-retirees in their 50s and 60s, a higher tax bill is sometimes the smartest move you can make. Here is why the conventional wisdom of always minimizing taxes may be working against you.

There is a deeply ingrained instinct among savers and investors to do whatever it takes to pay less in taxes right now. Defer the income, delay the gain, put it off as long as possible. It is advice that has been passed down through generations, and for a long time it made reasonable sense. But for many people in their 50s and 60s, blindly following that instinct is setting up a far more painful tax bill in the future, at exactly the wrong time.

The truth is that a strategically higher tax bill today can be one of the most powerful financial moves available to you. This is a recognition that timing matters enormously in tax planning, and that the goal has never been to pay the least amount of taxes possible in any given year, but to pay the least amount of taxes possible over your entire lifetime. Those are two very different things, and confusing them can cost you significantly.

If you have spent decades contributing to a traditional 401(k) or IRA, you have built something valuable. But you have also built a liability that most people do not fully appreciate until it is too late to do much about it.

For many, every dollar sitting in a traditional retirement account has never been taxed. The government allowed you to defer that tax obligation with the promise that you would pay it later. That day of reckoning arrives in the form of required minimum distributions (or RMDs) which currently begin at age 73 or 75. At that point, you have no choice but to pull money out of those accounts and pay ordinary income tax on it, whether you need the money or not.

For people who have saved diligently over a long career, those RMDs can be substantial. Combined with Social Security benefits, which may themselves be partially taxable, the result is often a tax burden in retirement that surprises people who spent their working years assuming retirement would be a lower-tax period.

Here is where the story gets interesting for pre-retirees. If you retire in your early to mid-60s and have not yet started collecting Social Security, you may find yourself in an unusually low-income period. Your earned income has stopped or slowed and you are not yet drawing on retirement accounts beyond what you choose to take. Your taxable income may be lower in this window than it has been in decades, and lower than it will be when RMDs kick in. That gap is an opportunity.

This is precisely the period when voluntarily paying more in taxes, on purpose and strategically, makes a great deal of sense.

Roth conversions: paying the toll before the road gets more expensive. A Roth conversion is the process of moving money from a traditional IRA or 401(k) into a Roth IRA. When you do this, you pay ordinary income tax on the amount converted in the year it happens. That is the voluntary tax increase that makes some people recoil, but consider what you get in return.

Money inside a Roth IRA grows tax-free, qualified withdrawals in retirement are completely tax-free and Roth IRAs are not subject to required minimum distributions during your lifetime, which means you retain full control over when and whether to take the money out.

A Roth conversion during a low-income year is essentially prepaying a tax bill at a discount. If you convert $50,000 in a year when you are in the 22% bracket, and that same money would otherwise be pushed out as an RMD in a year when you are in the 28% or 32% bracket, the math strongly favors paying now.

Done thoughtfully over several years, a series of Roth conversions can dramatically reduce the size of your taxable accounts, lower your future RMDs, reduce the likelihood that your Social Security benefits will be taxable, and even affect your Medicare premium calculations, which are based on income from two years prior.

Similar logic applies to long-term capital gains sitting in a taxable brokerage account. Many investors hold appreciated positions for years or even decades because they hate the idea of paying capital gains tax. The position grows, the tax liability grows with it, and they never pull the trigger.

But capital gains tax rates are progressive, and for individuals and couples in the lower income brackets, the federal rate on long-term capital gains can be zero. If your taxable income falls below certain thresholds, you can sell appreciated investments, realize the gain, and owe nothing to the federal government on those gains.

Even for people who do not qualify for the zero percent rate, intentionally recognizing gains in a lower-income year means locking in the gain at a 15% rate rather than a potentially higher rate later. This reduces the embedded tax liability in your portfolio going forward and gives you more flexibility in how you manage withdrawals and income in retirement. Deliberately recognizing a gain is not surrendering to the tax code. It is using it to your advantage while the conditions are favorable.

Financial planners often talk about this concept as tax bracket management. Rather than trying to stay as low in the tax brackets as possible every year, the goal is to distribute taxable income across your lifetime in the most efficient way. That sometimes means filling up a lower bracket on purpose.

Think of your tax brackets as buckets: the 10% bucket, the 12% bucket, the 22% bucket and so on. Every year, some portion of those buckets are already filled by your ordinary income. But in lower-income years, particularly the gap years before Social Security and RMDs begin, some of those lower-rate buckets may be only partially filled. Strategic conversions and gain realizations allow you to fill them deliberately, at rates that are lower than what you expect to face later. This is planning in its truest sense. Not reacting to your tax bill at the end of the year, but engineering your income across multiple years to stay in the most favorable position possible.

None of this is difficult to understand conceptually. The challenge is emotional. Writing a larger check to the IRS in April, or seeing a higher tax bill on a conversion, runs counter to every instinct that has been reinforced over decades of accumulation.

The most effective shift in thinking for pre-retirees is to stop measuring success by this year's tax bill and start measuring it by lifetime taxes paid. Paying $8,000 more this year to save $40,000 over the next two decades is not a loss, it is a significant return on a deliberate decision.

Tax planning in your 50s and 60s is not about minimizing what you owe right now. It is about designing a retirement income structure that keeps as much of your wealth working for you as possible, across all the years ahead. Sometimes the path to that outcome runs straight through a bigger tax bill today.

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IMPORTANT DISCLOSURES

This post was created with the assistance of AI tools for research and drafting.  It was reviewed, edited, and fact-checked by Georgia Lord before publication.  Please verify any critical information.

These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials. The information in these materials does not constitute tax or legal advice and may change at any time and without notice. Please consult with a qualified tax professional, attorney, or Wealth Manager regarding your specific situation.

Spire Wealth Management, LLC is a Federally Registered Investment Advisory Firm. Securities offered through an affiliated company, Spire Securities, LLC., a Registered Broker/Dealer and member FINRA/SIPC.