Thursday, November 9, 2023

Maximizing Your “Financial Gap Years”

 When someone uses the phrase “gap year,” we often think immediately of young adults who plan experiential learning activities (e.g., traveling, volunteering, and working) between high school and post-secondary education or college graduation and graduate school. In other words, something that young adults do in their late teens and 20s. Think Malia Obama and Elon Musk.


There are also gap years for older adults: the time between age 59.5 (when there are no more early withdrawal penalties on money removed from tax-deferred accounts) and the start of required minimum distributions (RMDs). RMDs must now begin at age 73 (those born from 1951 to 1959) and, starting in 2033, age 75 (those born in 1960 and later).


Many people are in a lower marginal tax bracket during their gap years (especially after leaving a primary career) than they will be later when RMD withdrawals must begin. If so, gap years provide an opportunity for proactive tax planning.


The key is for older adults to focus on things that they can control during their financial gap years. Full disclosure: I am currently in my financial gap years myself and taking several proactive tax planning steps. 

Below are six "gap planning" strategies that can work for some older adults:


Partial Roth Conversions- This involves gradually converting the balance in a traditional IRA to a Roth IRA over a series of years while you are in a lower marginal tax bracket. By doing so, you pay a small amount of additional tax in each gap year so the overall tax impact is less.


Social Security Delay- If possible (read: there are other available income sources), delaying Social Security up until age 70 (when delayed retirement credits end), not only results in larger future benefits, but it reduces taxable income during gap years to do Roth conversions or realize capital gains on taxable accounts before RMDs begin.


Pension Payment Sequencing- Taxpayers fortunate to have a pension may want to delay their work exit date/pension start date to do Roth conversions or realize capital gains on taxable accounts before RMDs begin. Individuals must “do the math” to see if this strategy will work.


Taxable Income Planning- Other income sources, besides Roth conversions and Social Security, must also be carefully managed during gap years so as not to “pile on” taxable income. Examples include limiting earned income from a job or self-employment to a certain dollar amount and using tax-loss harvesting to offset realized capital gains on investments.


Charitable Gifting- Financial gap years are a great time to take advantage of strategies that not only help a valued non-profit, but also provide income tax write-offs. Examples include charitable trusts, donor advised funds, and qualified charitable distributions after age 70.5.


Postpone Expenses- All of the above strategies involve reducing taxable income. Another way that some people proactively plan is to postpone deductible expenses until RMDs begin as a way to offset higher taxable income. Examples include an older landlord delaying rental property improvements until after RMD age and delayed itemized deduction bunching.

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.


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