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How Taxes Can Make or Break Your FI Plan
Two investors can retire with the same nest egg and live very different lives after taxes. Here’s how to plan across accounts and decades.
The Tax Triangle
- Tax-deferred: 401(k)/403(b)/Traditional IRA/TSP — pre-tax now, taxable later.
- Roth: Roth IRA/401(k) — after-tax now, tax-free later.
- Taxable/Brokerage: Flexible access; dividends/cap gains taxed as you go.
Goal: Diversify by tax treatment, not just by asset class. Options = lower lifetime tax.
Tax “Breakers” to avoid
- Early withdrawal penalties for tapping pre-tax accounts before 59½ without a plan.
- RMD squeezes: Large pre-tax balances cause high Required Minimum Distributions later.
- Stealth cliffs: ACA premium loss, child credit phaseouts, Social Security taxation, NIIT, Medicare IRMAA.
Tax “Makers” to use
Roth Conversion Ladder
Convert pieces of pre-tax money to Roth in low-income years before RMD age. After five years, converted amounts are accessible tax- and penalty-free.
0% Long-Term Capital Gains Harvesting
In low-income years, realize long-term gains up to the top of the 0% bracket, then immediately rebuy to step up basis—without changing your position.
Bracket Management
- “Fill” the 12% or 22% bracket strategically with conversions.
- Coordinate withdrawals across all three account types to keep MAGI in target ranges (e.g., to retain ACA subsidies).
- Use HSAs as a stealth Roth for qualified expenses (invest, reimburse later).
Case study: same nest egg, different net spend
Assumptions: $1.2M total; Scenario A is 90% pre-tax, 10% taxable. Scenario B is balanced across the triangle.
- Scenario A: High RMDs, limited flexibility; loses ACA subsidy pre-65; higher lifetime tax.
- Scenario B: Uses taxable + conversions to manage brackets; preserves subsidies; lower lifetime tax.
Action steps (annual rhythm)
- Project next year’s income (salary, dividends, interest, realized gains).
- Choose a target bracket and plan conversions/withdrawals to “fill” it.
- Harvest losses to offset gains/ordinary income when appropriate.
- Re-check during open enrollment (ACA/Medicare) for subsidy/IRMAA thresholds.
Next in the series: Asset Allocation Through Different FI Stages