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Understanding the retirement income valley

Key takeaways

  • The SECURE Act 2.0 has widened the "income valley" between retirement and when RMDs begin.
  • The extra time could result in reduced taxable income and a tax-planning opportunity.
  • Tax-savvy withdrawals, Roth IRA conversions, and other tactics could potentially help save you money during the income valley years.

Time can often be our most precious resource. That's particularly true when it comes to retirement planning and saving, where compound earnings and interest are essential to building one's nest egg.

Most people plan to fund their retirement through a combination of Social Security benefits, traditional and Roth retirement savings, and taxable accounts. And people often start retirement and claim their Social Security benefits when they reach full retirement age. For those born 1960 or later, their full retirement age is 67.

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Until recently, required minimum distributions (RMDs) commenced when retirees turned 72, requiring withdrawals from tax-deferred accounts like 401(k)s and IRAs, which in turn resulted in higher income. For someone retiring at age 67, however, this created a 5-year period known as the "income valley" during which income and associated taxable income might be lower, potentially resulting in lower tax rates.

Further, for those who didn't need to withdraw from their tax-deferred accounts during that 5-year period, taxable income in the income valley could drop as low as $0 due to the varying tax treatment of different income sources.

Thanks to the SECURE 2.0 Act, the 5 potential years in the income valley is increasing, and these same retirees will have even more time for potential account growth. Starting in 2023, the required beginning date (RBD) for RMDs increased to 73 for those people who haven't turned 72 in prior years. Beginning in 2033, the RBD jumps to 75 for people born in 1960 or later. And while that's many years away, if you're planning on retiring before your RBD, you can potentially benefit from the lower tax rates during the income valley for more years.

The income valley can be a good time to put a tax plan in place, because once you're out of the valley taxes on your ordinary income may increase again and RMDs may push you into a higher marginal tax bracket.

Why does the income valley exist?

The following is a hypothetical example of a couple named Sally and Carl with both taxable and tax-deferred assets entering retirement. It shows how they can fund their lifestyle, as well as some strategies they can implement during the income valley that could result in smoother (and potentially lower) tax bills during the income valley and throughout the rest of retirement.

The scenario is constructed in such a way as to make the point we often make, which is that as you are living in retirement, the different types of accounts you have may allow you to make strategic withdrawal decisions that ultimately influence how you realize taxable income. Therefore, there may be an opportunity to reduce tax liability in retirement. Individual circumstance will indicate to what extent this may be possible.

So let's assume Sally and Carl have a combined preretirement income of $120,000. Most people need to replace between 55% and 80% of their pretax, preretirement income after they've stopped working to maintain their lifestyle in retirement, according to spending data research by Fidelity.1 The drop in income need may result from many factors, including saving on commuting costs, no longer needing to save for retirement, and potential tax savings due to different types and sources of income. This hypothetical example estimates Sally and Carl's after-tax retirement expense at $76,000 a year.2

Among their considerations would be determining what resources they would have to live on during the income valley, and whether those will come from Social Security, their 401(k), taxable accounts, or a combination of all 3.

Once they have retired (meaning they no longer have income from work), their income drops substantially for 8 years. How far the income valley dips depends on how they manage their account withdrawals. That's because the Internal Revenue Service (IRS) doesn't consider withdrawals from different account types the same way. For example, withdrawals from a checking account would not have an impact on taxes.

Understanding the income valley

In this hypothetical example, Sally and Carl retire at age 67. They experience an income valley while they live off their checking account and begin to take withdrawals from their retirement savings. Importantly, withdrawals from their checking account are not considered gross income by the IRS and they can withdraw only the portion they need to meet expenses from their 401(k) prior to RMDs beginning. In later years, the income valley ends when RMDs begin.

Next we calculate Sally and Carl's tax situation each year. Due to the partial taxability of Social Security benefits and the standard deduction, Sally and Carl's taxable income could effectively fall to $0 once retirement begins.3,4

The table uses the inflation-adjusted standard deduction of $27,700 for 2023 and one additional $1,500 standard deduction each due to Sally and Carl since they are over age 65, plus $36,000 in annual Social Security benefits and $40,000 in taxable account withdrawals.5

Their taxable income falls to $0 and remains this low until they deplete their checking account and begin taking withdrawals from their 401(k) at age 72. Subsequently, when RMDs begin at 75, Sally and Carl's taxable income will rise as they are required to take distributions from their 401(k), which get larger over time. Their tax bills would grow as well, with occasional jumps as their income enters the next marginal bracket.

Making use of the income valley

The income valley years can create a valuable opportunity for tax planning. Here are 3 strategies to potentially consider using during those years, which might help reduce overall taxes or smooth taxes for some retirees.

1. Tax-savvy withdrawals

A tax-efficient withdrawal strategy once you're in retirement can help lighten your tax burden. One approach involves withdrawing first from taxable accounts—such as a non-interest-bearing checking account or brokerage account, then tax-deferred accounts, and finally with tax-free withdrawals from Roth accounts. While brokerage accounts may incur capital gains, long-term capital gains are taxed at 0% up to $89,250 in taxable income for a couple filing jointly or $44,625 for a single filer in 2023, and up to $94,050 for a couple filing jointly and $47,025 for a single filer in 2024.

Another approach is to make proportional withdrawals from each retirement savings account. Once a target amount is determined, you'd make withdrawals from each account based on the account's percentage of total savings. The overall effect could lead to more stable income as well as a more stable tax bill over time, by accelerating tax-deferred withdrawals and reducing future RMDs.

Additionally, proportional withdrawals could potentially lower lifetime taxes and potentially increase after-tax income by taking tax-deferred withdrawals during periods of low tax rates.

Keep in mind, however, that accelerating tax-deferred withdrawals from tax-deferred accounts may add to your ordinary income, which in turn could increase taxes on Social Security income, and potentially higher monthly payments for Medicare due to the Income-Related Monthly Adjustment Amount, or IRMAA. Consult a tax advisor to determine what makes sense for you.

Read more about Tax-savvy withdrawals in retirement in Viewpoints.

You can also gauge the potential effect of retirement income strategies on your taxes with Fidelity's retirement strategies tax estimator.

2. Consider a Roth conversion

If you have more resources, it may make sense to pay taxes on Roth conversions when your tax rate is low or even 0%, and after that you won't have to take RMDs from your account once it's converted. Additionally, qualified withdrawals from a Roth account in retirement are tax-free, assuming the 5-year aging rule has been met. A Roth IRA conversion will also decrease the amount of money in your tax-deferred accounts, meaning when you do start taking your RMDs from your tax-deferred accounts, your distribution amounts and taxes will also be lower. Similar to the tax-savvy withdrawals strategy, Roth conversions may also add to your ordinary income, which in turn could increase taxes on Social Security income. They could also lead to potentially higher monthly payments for Medicare premiums due to the IRMAA.

Read more about Roth IRA conversions in Viewpoints: Why consider a Roth conversion now?

3. Charitable giving may help

If you don't need the money, and you're feeling charitably minded, consider making charitable donations. For those who itemize or for whom a charitable donation would make itemizing more advantageous, a charitable donation can deepen the income valley by expanding the amount of income that is not taxed.6 This could mean more opportunity for the strategies mentioned above, or simply help reduce taxes during the income valley years.

Clients with more means could also consider a qualified charitable distribution (QCD). It's a direct transfer of funds from your IRA custodian, payable to a qualified charity. You can do a QCD of any amount, with a maximum of $100,000 per individual per year in 2023, and $105,000 in 2024. QCDs are especially valuable once required minimum distributions (RMDs) begin if you don't need the full RMD for expenses. Note: Itemization is not required to make a QCD. While the QCD amount is not taxed, you may not then claim the distribution as a charitable tax deduction.

For a deeper dive on charitable giving explore Viewpoints: Strategic giving: think beyond cash.


Of course, not everyone may have sufficient flexibility to manage their retirement income in the most tax-efficient way by choosing from taxable, tax-deferred, and tax-free accounts. Some people may only have tax-deferred assets to withdraw from, such as a 401(K) or an IRA, in which case they will have little choice other than to generate taxable income, or live on a lower amount of income. Others may have more flexibility, for example a taxable checking or savings account. The change in income from preretirement to retirement can be huge for many, and the key to taking advantage of the "income valley" is flexibility.

Many people can smooth out their income in retirement through pensions, annuities, or maximizing their Social Security benefits. Other sources of income like part-time work or rental properties may continue into retirement, too. While having stable sources of income in retirement may reduce the need for withdrawals in the first place, they may also increase your income and limit your flexibility to manage taxable income through withdrawals. That's because you can control how you take withdrawals, but you can't control how your income is taxed.

SECURE 2.0 expanded opportunities for retirement saving, including increasing the age at which required minimum distributions begin. Make sure to speak with your financial advisor or tax professional to understand how these changes might affect you.

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More to explore

1. Fidelity analyzed the household consumption data for working individuals age 50 to 65 from Consumer Expenditure Survey, US Bureau of Labor Statistics. The average income replacement target of 45% is based on the objective of maintaining a similar lifestyle to before retirement. This target is defined at 35% for "below average" lifestyle and 55% of preretirement income for "above average" lifestyle. Therefore, the final income multiplier target of 10x final (preretirement) income associated with the default "average lifestyle" (maintaining preretirement lifestyle in retirement) and a default retirement age of 67, goes down to 8x for "below average" lifestyle and increases to 12x for "above average" lifestyle. See footnote 3 for investment growth assumptions. 2. Assumes an 80% replacement rate and a 20% effective tax rate preretirement. $120,000 replaced at 80% is $96,000. Further reduced by 20% in taxes, that may not be paid in retirement, results $76,800. This tax rate was estimated by calculating effective federal, wage, and state taxes on an income of $120,000 in 2023. State tax rates is assumed to be 5%. 3. Social Security benefits are only partially taxable at the Federal level. The minimum taxability is 0% and the maximum is 85%. 4. While most income brackets are fixed based on filing status, the 0% bracket can vary from a low of the standard deduction (increased if you are age 65 or older), to a high of your itemized deductions. Consider ways to manage your deductions such as mortgage interest, state and local taxes (including property taxes), charitable donations, and large medical expenses, among others. 5. Assumes no state income taxes apply, and depending on retirement state, marginal tax rate could be significantly higher. 6. Charitable donations are deductible as a portion of AGI based on the source of the donation and the receiving charitable organization. Unused deductions may be carried forward to future years for up to 5 years.

For a distribution to be considered qualified, the 5-year aging requirement has to be satisfied, and you must be age 59½ or older or meet one of several exemptions (disability, qualified first-time home purchase, or death among them).

Fidelity does not provide legal or tax advice. The information herein is general and educational in nature and should not be considered legal or tax advice. Tax laws and regulations are complex and subject to change, which can materially impact investment results. Fidelity cannot guarantee that the information herein is accurate, complete, or timely. Fidelity makes no warranties with regard to such information or results obtained by its use, and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. Consult an attorney or tax professional regarding your specific situation.

This information is intended to be educational and is not tailored to the investment needs of any specific investor.

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