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Benefits of tax bracket arbitrage

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Timothy Callan

IRAs and other tax-advantaged accounts are generally considered great vehicles for saving money before and during the early years of retirement. Until you’re 59½, you’re penalized (with few exceptions) for withdrawing money1 and at age 70½, the IRS requires distributions to start over your remaining life expectancy2. Additionally, not withdrawing funds is often viewed as a virtue, since once you withdraw, you are taxed on those funds. For these reasons, many people don’t begin withdrawing funds from their IRAs until they are required by the IRS to take a Required Minimum Distribution (RMD) — this is how the IRS gets what they’re owed from you after all those years of not paying taxes on a portion of your income. Sounds like a good deal — deferring taxes for at least another 10 years? In our opinion there’s a catch: RMDs are calculated as a percentage of the account’s year-ending value — and the rate increases each year — and taxed as normal income3. For those disciplined savers and investors, this could mean they have amassed large tax-deferred balances and will have a corresponding large RMD, leading to an unexpected large tax bill, when they might not otherwise have earned income to declare.

One possible way, in our opinion, to mitigate the tax bill upon reaching RMD age (since you can’t fully escape it), is to smooth income over time, by systematically withdrawing from tax-deferred accounts after retirement — up to a point. By taking money out of the account during low- or no-income years but keeping total taxable income to the 15-25% tax brackets, you can potentially slowly reduce or maintain (but not grow) the balance of the tax-deferred assets and therefore keep the RMD from breaching the upper tax bracket thresholds. Many people have several years of low income between retirement and the age when RMDs begin. We believe you’re better off taking distributions at the low tax bracket, even if it means you’ll be paying taxes earlier than the IRS requires. If you can take consistent distributions at the lower tax rates from age 60-70 versus waiting until age 70½ and being forced to distribute at the higher tax rates, in our opinion you’ll come out ahead.

One can still be financially prudent by employing this type of tax bracket arbitrage. You can reinvest the funds in a taxable account or convert them to a Roth for a potential further tax advantage (if you qualify).

This strategy also applies to taxable accounts by harvesting capital gains in the same way. In the low- or no-income years after retirement, you can realize gains in your taxable portfolio and pay a comparatively small tax bill in exchange for essentially a step-up in the cost basis. Unlike loss harvesting, when you harvest gains, there is no period of time that you can’t buy back the stock (the "wash sale" rule4). Thus, when you sell the position again in the future, the gain will be less than if you had held it the entire time, thus breaking up your tax bill over time.

Keep in mind; this is not a one-size-fits-all strategy. It is simply another tactic that can be used, if appropriate, to move you incrementally forward toward your financial goals. It should be reviewed with both a tax advisor and an investment advisor to ensure it is implemented appropriately for your unique financial situation.


1 "Age 59½ Rule" from IRS Publication 590, p.56 (2013)

2 "When Must You Withdraw Assets? (Required Minimum Distributions" from IRS Publication 590, p.34 (2013)

3 "Are Distributions Taxable?" from IRS Publication 590, p.41 (2013)

4 "Wash Sales" from IRS Publication 550, p.58 (2013)

Disclaimer: *Callan Capital does not provide individual tax or legal advice, nor does it provide financing services. Clients should review planned financial transactions and wealth transfer strategies with their own tax and legal advisors. Callan Capital outsources to lending and financial institutions that directly provide our clients with, securities based financing, residential and commercial financing and cash management services. For more information, please refer to our most recent Form ADV Part 2A which may be found at www.adviserinfo.sec.gov.


Timothy S. Callan, CFP® is a Managing Partner at Callan Capital in La Jolla, CA. Tim can be reached at 858.551.3800 or tim@callancapital.com. Callan Capital is an independent wealth management firm that provides financial planning and asset management services to affluent families, executives, foundations and endowments. For more information on tax bracket arbitrage or Callan Capital’s suite of services, please visit www.callancapital.com.

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