Tax Bracket Topping: Why “Spending Your IRA Last” is a Million-Dollar Mistake
Tax Bracket Topping: Why “Spending Your IRA Last” is a Million-Dollar Mistake
๐ WHO THIS IS FOR
- Target Profile: Retirees with significant Pre-Tax assets ($1Mโ$5M in IRA/401k) and some Taxable savings.
- Primary Objective: Lifetime Tax Minimization (Reducing the total tax bill over 30 years, not just this year).
- Not Suitable For: Retirees with little to no Pre-Tax savings or those already in the highest tax bracket.
EXECUTIVE SUMMARY
- The Old Rule: “Sequential Withdrawal.” Spend Taxable accounts first, then Roth, and touch Traditional IRAs last to defer taxes as long as possible.
- The Trap: By deferring IRA withdrawals, the account grows unchecked. At age 73, Required Minimum Distributions (RMDs) kick in. The forced withdrawals push you into the 32%, 35%, or 37% tax bracket, causing massive tax leakage.
- The Solution: “Tax Bracket Topping.” You intentionally withdraw (or convert) funds from your IRA annually to “fill up” the lower tax brackets (12%, 22%, 24%).
- The Payoff: By voluntarily paying tax at 22% today, you avoid being forced to pay 35% later. This arbitrage can save $300kโ$500k over a retirement lifetime.
Most CPAs are trained to minimize your tax bill this year. A Wealth Strategist is trained to minimize your tax bill over your lifetime. Deferring taxes is not always good if you are deferring into a higher future rate. The years between retirement (e.g., 60) and RMDs (73) are the “Golden Window” to defuse the RMD bomb. According to Team BMT Analysis, “Bracket Topping” is the single most effective way to utilize the current low tax rates before they expire. Source: Kitces.com / J.P. Morgan Asset Management
Scenario: Married Couple, Age 62. Needs $100k/year income. RMDs start at 73.
- Strategy A (Deferral – The Mistake):
Spend $100k from Cash/Brokerage. Taxable Income: $0.
Tax Rate: 0%. (Feels good now).
Result at Age 75: IRA grew to $4M. RMD is ~$160k + Social Security. Pushed to 32% Bracket. - Strategy B (Topping – The Fix):
Spend $100k from Brokerage. BUT also convert/withdraw $120k from IRA.
Tax Rate: Pay 12% or 22% on the IRA money now.
Result at Age 75: IRA is smaller. RMDs are manageable. You never touch the 32% bracket.
Verdict: You paid 22% voluntarily to save 10% later.
BMT Verdict: A tax bracket is a “use it or lose it” asset. Every year you have room in the 12% or 22% bracket and don’t use it, you have wasted an opportunity to liberate money from the IRS at a discount. Don’t let a low-income year go to waste.
Lifetime Tax Liability Comparison
| Withdrawal Strategy | Total Taxes Paid (Age 60-95) |
|---|---|
| Sequential (Defer IRA to Last) | 850000 |
| Bracket Topping (Proportional) | 520000 |
*Chart Note: The massive difference comes from avoiding the “Tax Torpedo” in later yearsโwhere RMDs cause Social Security to become 85% taxable and push capital gains into higher brackets.
Legislative Deadline: The Tax Cuts and Jobs Act (TCJA) of 2017 lowered federal tax rates (e.g., 22% and 24%). These rates are scheduled to sunset on December 31, 2025, reverting to higher pre-2018 levels (e.g., 25% and 28%). We are currently in a “Tax Sale.” It is mathematically urgent to accelerate income into 2024 and 2025.
โ BOUNDARY CLAUSE: This Structure Breaks Down If:
- Charitable Intent: If you plan to donate your entire IRA to charity via QCDs (Qualified Charitable Distributions) or at death, do not pay tax now. Let the charity receive it tax-free.
- IRMAA Cliffs: Withdrawing too much can trigger higher Medicare premiums (IRMAA). You must calculate the “Topping” amount precisely to stay just under the IRMAA surcharges ($206k/$412k MAGI).
Execution Protocol
For 2024, the 24% bracket for married couples ends at ~$383,900 of Taxable Income. Calculate how much room you have between your current income and this ceiling.
Instead of just withdrawing cash to spend, convert the “Gap Amount” from Traditional IRA to Roth IRA. You pay the tax now, but the money stays invested and grows tax-free forever.
Do this every year in Q4 (when your income is clear). This systematically “drains the swamp” of your pre-tax accounts before RMDs force your hand.
Tax planning is not about paying $0 this year. It is about paying the lowest average rate over your life. Sometimes, paying taxes voluntarily is the smartest investment you can make.
WEALTH STRATEGY DIRECTIVE
- Do This: Look at “Line 15” of your 1040 form. If your Taxable Income is significantly lower than the top of the 22% or 24% bracket, you missed an opportunity. Fill it up.
- Avoid This: “Tax-Loss Harvesting” without considering the income side. Sometimes it is better to realize gains (Tax-Gain Harvesting) to fill the 0% Capital Gains bracket (up to ~$94k for couples).
Frequently Asked Questions
Does this affect Social Security taxes?
Yes. Increasing income can make more of your Social Security taxable (up to 85%). However, once you are past the “Tax Torpedo” zone, filling the bracket is still usually beneficial compared to future RMD rates.
Can I undo a conversion?
No. The “Recharacterization” rule was eliminated by the TCJA in 2017. Once you convert to Roth, it is permanent. Measure twice, cut once.
What if I move to a no-tax state?
If you live in New York (High Tax) but plan to retire in Florida (No Tax), wait to withdraw until you move. The state tax savings (up to 10%+) might outweigh the federal bracket arbitrage.