Tax Alpha Part Two: How to save money on taxes with multi-year tax planning

IRAs, 401ks, & 403bs all require you to begin distributions in the year you turn 70.5.  Strategic tax planning can help you mitigate the looming tax increase you’ll face once distributions occur.

Note: these are thoughts purely from a tax perspective; investment considerations may call for different timing.

  • Take IRA distributions toward the end of the year so you’ll have deferral and growth all year long.
  • Make retirement contributions as early as possible so you’ll gain tax-free growth.
  • In the case of very large IRA balances, it may make sense to being distributions before age 59.5. This is an income smoothing strategy and helps mitigate the big bump in required minimum distributions and associated taxation. There are a handful of exceptions to the 10% penalty, most notably the waiver for substantially equal periodic payments (a.k.a 72t distributions).
  • Give appreciated securities rather than cash! Qualified charities can sell your appreciated securities without taxation. You get a full deduction for the fair market value of the gift, subject to AGI limitations.
  • Donor Advised Funds (DAF) allow you to make large charitable gifts and receive an immediate charitable tax deduction in a single year (subject to AGI limitations) while spreading the actual disbursements to charitable organizations over multiple years while still retaining control. Learn more on donor advised funds here.
  • DAF’s are a powerful tool when used in high-income years, such as receiving a one-time bonus, the sale of a business, a lump-sum distribution of low-basis company stock (NUA), or my personal favorite: Roth IRA conversions. The Roth conversion coupled with a DAF allows you to reduce future federal income taxes while staying tax neutral in the current year.
  • Net unrealized appreciation (NUA) allows you to remove company stock from a company retirement plan and place it into a regular taxable account. You pay tax only the plan’s cost basis. As you sell shares in the future, you pay capital gains tax instead of the ordinary income tax you’d normally pay on a distribution from a qualified plan or IRA. Using NUA can be a powerful strategy to extract money from a 401k in a tax preferential way. A lump-sum distribution of the participant’s entire account balance within a calendar year is required in order to preserve NUA treatment. Do not attempt this without advice.
  • Advanced gifting: CRATs, CRUTs, and NIMCRUTs are acronyms for various flavors of Charitable Remainder Trusts. These are potentially useful in diversifying concentrated positions, spreading gains over multiple years, or pushing taxable income into future years.

Which accounts should you tap first?

  • Generally if your income is going to be higher in the future, use tax deferred, then taxable, then tax-free accounts.
  • If you expect the same or lower income in the future, your strategy may shift to taking income from taxable, tax-deferred and ultimately tax-free accounts.

The thoughts on this page are mostly concerned with “good” tax moves. Nevertheless, other factors in your financial plan, notably specific investments inside the various vehicles we’ve mentioned, may suggest you go against the grain. Good investment decisions don’t always mean you’ve made the lowest cost near-term tax move. Balancing these factors is part of a comprehensive financial plan.

As you think about your own tax situation, keep the following in mind:

  • Stay aware of tax brackets and deduction limitations.
  • Use statutory tax shelters such as IRAs, 401k’s, 403b’s, deferred compensation arrangements, and perhaps even low-cost variable annuities or life insurance for tax-deferral and tax-free growth.
  • Use Roth tax shelters for future tax-free withdrawals.
  • Make small moves each year to create tactical tax alpha.
  • In years when your income is exceptionally high or exceptionally low, consider big moves for strategic tax alpha.
  • The purchase or sale of any assets such as stocks, bonds, mutual fund, homes, or a business may present a great tax-planning opportunity.

High-income earners must be aware of the 3.8% surtax on net investment income. If your MAGI (modified adjusted gross income) is above these threshold amounts:

  1. Married taxpayers filing jointly – $250,000
  2. Married taxpayers filing separately – $125,000
  3. All other individual taxpayers – $200,000
  4. Trusts and estates – $12,150

Then you may be subject to the surtax on investment income which includes the following:

Interest, dividends, capital gains, annuity income, rents, royalties and & passive activity income


It excludes the following:

  • Active trade and/or business income: any of the above sources of income above (e.g. interest, dividends, capital gains, etc.) to the extent derived from an active trade and/or business;
  • Distributions from IRAs or other qualified retirement plans; and
  • Any income taken into account for self-employment tax purposes.

A strategic tax plan can help you manage and possibly avoid the 3.8% surtax.

Be sure to read part one where we discuss basic tax planning strategies using Roth IRAs, taxable accounts, and low-income years.

investing for retirement ebook ipad - McClain Lovejoy
investing for retirement ebook ipad - McClain Lovejoy
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