Tax Planning Strategies to Shift Income to Lower Brackets

Smart tax planning will save you money in retirement

Couple adding up receipts for tax planning.
••• Andersen Ross/Blend Images/Getty Images

No one wants to pay more than they have to during tax season. In order to engage in tax planning that can reduce the amount of tax you will owe, you must understand how the tax brackets work. 

How Tax Brackets Work

Here’s a quick primer on how tax rates work. This is an example for married couples filing jointly (2020 rates):

  • Every dollar of taxable income between 0 and $19,750 is taxed at a 10% rate.
  • Every dollar between $19,751 and $80,250 is taxed at 12%.
  • Every dollar of taxable income over $80,251 and up to $171,050 is taxed at 22%.

The chart below illustrates the tax brackets, rates, and liability for those married and filing jointly in 2020 and 2021.

Tax Brackets for Married Filing Jointly: Tax Year 2020
Tax Bracket Tax Rate Tax Liability
$0-$19,750 10% 10% of income
$19,751-$80,250 12% $1,975 + 12% of income over $19,750
$80,251-$171,050 22% $9,235 + 22% of income over $80,250
$171,051-$326,600 24% $29,211 + 24% of income over $171,050
$326,601-$414,700 32% $66,543 + 32% of income over $326,600
$414,701-$622,050 35% $94,735 + 35% of income over $414,700
$622,051+ 37%  $167,308 + 37% of income over $622,050
Tax Brackets for Married Filing Jointly: Tax Year 2021
Tax Bracket Tax Rate Tax Liability
$0-$19,900 10% 10% of income
$19,901-$81,050 12% $1,900 + 12% of income over $19,900
$81,051-$172,750 22% $9,328 + 22% of income over $81,050
$172,751-$329,850 24% $29,502 + 24% of income over $172,750
$329,851-$418,850 32% $67,206 + 32% of income over $329,850
$418,851-$628,300 35% $95,686 + 35% of income over $418,850
$628,301+ 37%  $168,993.50 + 37% of income over $628,300

Next, Put Together a Tax Projection

Once you understand how the tax brackets work, you must do a tax projection before the end of each year. This projection is an estimate of what you think your taxable income will be. This estimate is necessary for you to determine which strategies will work best for you.

If your taxable income will be $80,000 or higher, read on to find ways to drain income from the top brackets. If your taxable income will be $80,000 or lower, read below to learn why you want to be sure to fill up the bottom tax brackets.

The chart below illustrates the tax brackets, rates, and liability for single filers for tax years 2020 and 2021.

Tax Brackets for Single Filers: Tax Year 2020
Tax Bracket Tax Rate Tax Liability 
$0-$9,875 10% 10% of income 
$9,876-$40,125 12% $988 + 12% of income over $9,875
$40,126-$85,525 22% $4,618 + 22% of income over $40,125
$85,526-$163,300 24% $14,606 + 24% of income over $85,525
$163,301-$207,350 32% $33,272 + 32% of income over $163,300
$207,351-$518,400  35%  $47,368 + 35% of income over $207,350
$518,401+ 37% $156,235 + 37% of income over $518,400
Tax Brackets for Single Filers: Tax Year 2021
Tax Bracket Tax Rate Tax Liability 
$0-$9,950 10% 10% of income 
$9,951-$40,525 12% $995 + 12% of income over $9,950
$40,526-$86,375 22% $4,664 + 22% of income over $40,525
$86,376-$164,925 24% $14,751 + 24% of income over $86,375
$164,926-$209,425 32% $33,603 + 32% of income over $164,925
$209,426-$523,600  35%  $47,843 + 35% of income over $209,425
$523,601+ 37% $157.804.25 + 37% of income over $523,600

Taxable Income Over $80k Married, $40k Single

High-income filers need to find ways to drain income from the top tax brackets.

Example: Using the tax brackets at the top of this article, for a married couple, if you had $86,850 of taxable income, the top $6,600 of that income will be taxed at 24%. You will pay $1,584 of tax on that $6,600 of income.

Use the following ideas to shift income to a lower bracket:

  • Rearrange your investments to reduce taxable income. You want investments that generate interest income to be held inside retirement accounts, and investments that generate capital gains and qualified dividends to be held outside of retirement accounts.
  • Take less money out of retirement accounts in years where other sources of income are higher.
  • Realize capital losses to offset capital gains.
  • For high-income earners, make deductible contributions to retirement plans. This makes great sense if you fall in the 32% or 35% tax bracket. Why? Most likely when you retire and begin taking withdrawals, your tax bracket will be lower, in the 12% to 24% range. If you can deduct money today at 35%, and pay tax later at 12%, that results in big savings.
  • Increase retirement plan contributions as limits rise. Each October the IRS announces the new contribution limits for 401(k)s, IRAs, and other retirement plans. Each year, be sure to adjust your payroll contributions to put the maximum amount into your plans. In 2020 and 2021, for example, the 401(k) contribution limit for those age 50 and older is $25,500, which includes the $6,000 catch-up provision.

Taxable Income Less Than $80k Married, $40k Single 

Lower-income taxpayers should make different choices to maximize tax savings. A few options:

  • Perhaps you should not contribute to a deductible retirement account. Instead, fund a Roth IRA, or make Roth contributions to your 401(k) plan.
  • Use low-income years to take IRA withdrawals and pay little to no tax. See details about this tax planning strategy below.
  • Consider converting your IRA account, or a portion of it, to a Roth IRA.

1. Use low-income years to fund tax-free Roth accounts

In years where your taxable income will be low, Roth IRA or Roth 401(k) contributions make sense.

For example, a real estate agent routinely made annual tax-deductible contributions to her 401(k) plan. At the end of a slow year, she looked at her tax situation and realized she would be in a low tax bracket that year.

It made no sense for her to make a deductible contribution in order to save 10% in taxes now, only to make withdrawals 10 years from now, and pay tax at a projected 12% rate then. So she contributed to a Roth IRA instead of making deductible contributions to her 401(k) plan.

2. Take IRA Withdrawals

For those age 59½ or older, you might consider taking IRA withdrawals during low-income years, even if you are not required to. Here's why this can work. After adding up itemized deductions, such as mortgage interest and health care expenses, some retirees have more deductions than income. In years where this occurs, this can be a great opportunity to withdraw funds from retirement accounts and pay tax at only the 12% or 22% rate.

Instead, many retirees follow conventional wisdom and let tax-deferred accounts grow until they are forced to take required minimum distributions at age 70½. If you wait until age 70½, the required minimum distribution may be large enough that the extra income then shifts you into a different tax bracket.

By taking withdrawals in years where taxable income is low, you can potentially avoid paying an extra 10% to 15% tax on withdrawals later down the road.