The 3 Biggest Tax Mistakes Retirees Can Make in Their 60s: One Involves Roth Conversions
Your 60s can be the most valuable decade in your life, but far too many people miss valuable tax planning opportunities that can lower their lifetime tax bills.
Bob and Sue thought they had it made when they retired at 63. They had hit their savings goal of $2 million, and their house was paid off.
They felt their work stress slip away as they settled into their retired life.
Their morning commute turned into coffee on the porch. The only deadline they had was signing up on time for their pickleball league. And their projection of lower taxes at retirement was spot on.
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With Social Security and a pension covering their bills, and their savings account covering "extras" like travel and gifts to the grandkids, their first retirement tax bill was much lower than when they were working.
Life was carefree — until they turned 73 and they got their first notice for required minimum distributions (RMDs).
Thankfully, their retirement money had grown. But now, more than $3.2 million in their traditional retirement accounts was subject to RMDs.
They were required to take out more than $120,000 in taxable income each year, and their RMDs were projected to grow even higher in the future.
When they retired, Bob and Sue figured their RMDs would push them into a higher tax bracket, but they didn't think it would be that bad.
But when they got there, they wished they had done something about the RMD problem sooner.
Sadly, Bob and Sue — and far too many others in their 70s — had missed what I call their "golden tax planning window." In their 60s, they could have chosen how much of their retirement income would be taxable, instead of being required to take a minimum taxable amount when they hit RMD age.
They thought they had their taxes set in their 60s because they had a lower tax bill each year than when they were working.
Yet they were unknowingly making a huge tax mistake each year by failing to use tax planning strategies that would help them avoid nasty tax surprises in their 70s.
Here are the three biggest mistakes I believe retirees can make during the golden tax planning window.
Tax Mistake No. 1: Missing the best years for Roth conversions
Bob and Sue were actually enjoying tax season in the early part of retirement. They were in a lower tax bracket than when they were working and they really weren't worried about how much they owed, or whether they were facing a tax penalty.
But then they were faced with their first RMD of more than $120,000.
That caused their Social Security to go from a small amount showing up as taxable to the maximum 85% showing up as taxable income.
And it pushed them from regular Medicare costs to paying extra through the IRMAA (income-related monthly adjustment amount) Medicare surcharges.
Each low tax year of their 60s felt like a win. Instead, it was a missed opportunity to take advantage of their lower tax bracket by making use of Roth conversions.
A Roth conversion allows you to intentionally pay taxes — within the tax bracket you'd like — by choosing the timing and amount of your traditional IRA that shows up on your tax return.
This level of control on the timing of your tax payments is generally the biggest during your golden tax planning window — the time between when you retire and when your RMDs start at 73.
When you retire in your 60s, your taxable income is generally the lowest it's been in decades. This allows you to convert part of your traditional IRA to a Roth IRA so that your future gains can grow tax-free — and won't be subject to required taxable distributions later on as an RMD.
Here is a three-step action framework I created to help retirees in their 60s make the most of their golden window:
Find your lower-income years: Usually these are the gap years between when you stop working and when guaranteed retirement income (pensions, Social Security benefits, RMDs) begins.
Estimate your future RMDs: Using the IRS' formula, calculate what your traditional IRA balances will be at your RMD ages, how large those RMDs will be and how much you'll have to pay in taxes.
Compare your current versus future tax brackets: If your tax rate on a Roth conversion during your golden window is lower than the tax rate on an RMD will potentially be in the future, that's your opportunity to reduce your overall lifetime taxes.
Tax Mistake No. 2: Forgetting the tax component of Social Security
Bob and Sue were like many retirees who view Social Security strictly as an income decision.
They were like many of their friends, who took their Social Security right away because it helped them get enough income to retire.
Other retirees look at the near 8% growth on waiting to file Social Security and they choose to delay their claiming, so they get the most income later on.
Whether you take Social Security early or late, focusing just on the income component may often mean you overlook the tax flexibility and lifetime tax bill that your Social Security decision can create.
Start claiming Social Security too soon, and you might drive up your taxable income for the rest of your retirement. This could potentially slam shut your golden window for Roth conversions, resulting in higher RMDs later on.
On the other hand, if you start claiming maximum benefits at 70, and you haven't already made moves to reduce the taxable impact of your RMDs, you could be facing the same basket of tax problems.
Sure, in a vacuum, letting your Social Security benefits grow by approximately 8% per year is a smart move. But maintaining long-term financial flexibility and reducing your lifetime tax liability are also parts of the Social Security equation.
Before claiming your Social Security benefits, remember to:
Evaluate your claiming age: Calculate how your projected benefits at various ages affect the other parts of your financial plan — especially taxes and your golden window for Roth conversions.
Compare your tax projections: Run scenarios showing how your taxes could look if you claim at 62 versus claiming at full retirement age and later.
Target Roth conversion opportunities: Once you start taking Social Security, your golden window for Roth conversions starts to close. Make the most of these low-tax years before you are on Social Security so that you're taxed less in the future as well.
Tax Mistake No. 3: Leaving the survivor with the 'widow's penalty'
No one wants to imagine a world without them or their spouse in it. But preparing for both of those difficult scenarios is an important part of retirement planning.
Bob and Sue were fortunate to both be living as they hit their RMD age of 73. But at some point, one of them will pass away. The other could be faced with the same RMD amount but with the single taxpayer brackets, instead of married filing jointly brackets.
When you transition from a married couple filing taxes jointly to a single filer, the tax brackets and the standard deduction are cut in half. But RMD percentages often stay relatively the same — and the taxable RMD amount stays relatively the same.
With a similar taxable distribution, and half the room in each bracket, the widow runs through the tax brackets quicker, getting to the higher tax rates quicker.
For a surviving spouse, the taxable income often stays nearly the same, yet their tax bill goes up.
To avoid this "widow's penalty," you can take the opportunity during your golden window to:
Model survivor tax projections: What will each spouse's income and tax brackets look like if they become a single filer at various ages?
Consider Roth conversions while filing jointly: Take advantage of the wider married filing jointly tax brackets while you both are still living. The more money you can convert into a Roth IRA now, the more potential tax-free money a surviving spouse will have in the future.
Evaluate the long-term household tax burden: Too many 90-year-old widows are living off the income and tax decisions their husbands made decades ago. Couples should plan for each survivor's long-term tax scenario before they start claiming Social Security.
Create your tax-smart retirement plan
When you consider not just this year's taxes, but your lifetime tax bill, your 60s might be the most valuable decade of your entire life.
And while each of these three mistakes — missing out on Roth conversions, forgetting the tax aspect of Social Security and leaving the survivor with the widow's penalty — can be costly, I believe the biggest retirement planning mistake you can make in your 60s is not realizing how each decision coordinates with the other.
The key to retirement planning, which I cover in more detail in chapter 5 of my book Retire Today, is to follow a system that helps you make retirement decisions in a coordinated manner.
During the golden window you can often manage your tax strategy for the rest of your retirement by:
Using your lower-income years intentionally: Pay lower taxes today "on purpose" through Roth conversions.
Evaluating Social Security through a tax lens: Don't just claim benefits because you stopped working. And don't delay taking benefits just to maximize them. Consider, as well, using your Social Security plan to help lower your lifetime taxes.
Planning for the survivor tax situation before it happens: Try to avoid the "widow's penalty" by shifting taxable IRAs to the tax-free growth potential of Roth IRAs while you still have the advantage of larger tax brackets on your married filing jointly tax return.
Remember: Once the golden tax planning window closes, it's likely closed for good. Unlike Bob and Sue, use the lower tax brackets you might find in your 60s to lower your tax bill over your lifetime.
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