Legally Reduce Lifetime Tax and Make the Same Income? Yes!

Nobody likes paying taxes.

At best, we realize it’s a necessary evil, allowing the government to provide society-wide services we can’t buy.

Things like the interstate highway system, major bridges and dams, policing, a functioning justice system, and national defense, to name a few.

However, as Judge Learned Hand once wrote, “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury. There is not even a patriotic duty to increase one’s taxes. Over and over again the Courts have said that there is nothing sinister in so arranging affairs as to keep taxes as low as possible. Everyone does it, rich and poor alike and all do right, for nobody owes any public duty to pay more than the law demands.”

With that in mind, how do we “arrange [our] affairs so that [our] taxes are as low as possible”?

A Simple Idea with Significant Consequences

The federal income tax is progressive.

No, not Progressive, as folks on the political left call themselves.

Progressive, as in having the rate at which a dollar of income gets taxed increase as income increases.

For example, according to the IRS, the tax rates for 2024 (for married couples filing jointly) are:

• 10 percent on every dollar of taxable income up to $23,200
• 12 percent on every dollar from $23,201 to $94,300
• 22 percent from $94,301 to $201,050
• 24 percent from $201,051 to $383,900
• 32 percent from $383,901 to $487, 450
• 35 percent from $487,451 to$731,200
• 37 percent from $731,201 and up

Say you and your spouse file jointly and have a taxable income of $100,000. You don’t pay 22 percent on the full $100,000. Rather, you pay:

• $2,320 on the first $23,200 (10 percent)
• $8,532 on the next $71,100 (12 percent)
• $1,254 on the remaining $5700 (22 percent)

Your total (federal) income tax liability in this scenario would be the sum of the three amounts, or $12,106. Sure, your marginal tax rate would be 22 percent, but your effective tax rate would be 12.1 percent.

Why is this important?

Ah, here we come to the crux of the matter.

Say your income isn’t the same each year and doesn’t consistently increase each year.

In this scenario, if you could cause your taxable income to increase in years when it’s low, and decrease in years when it’s high, you will reduce your lifetime taxes. As Kevin Estes, Founder & Financial Planner, Scaled Finance says, “Because the US tax system is progressive, it may make sense to lower income in high-income years and raise it in low-income years, thereby lowering lifetime taxes.”

Here’s a comparison for a hypothetical scenario of a couple filing jointly, call them John and Mary. In this example, we simplify by using the 2024 tax brackets for all years, ignoring any inflation-driven changes; assuming all income is from wages; and applying the standard deduction.

In the first table, we see the total federal tax liability each year and summed over six years (for brevity, we’ll look at the six years rather than a full adult lifetime).

Year	Income	After Std Deduction	Federal Income Tax	Effective Tax Rate
1	$110,000	$80,800	$      9,232	8.4 percent
2	$135,000	$105,800	$    13,382	9.9 percent
3	$120,000	$90,800	$    10,432	8.7 percent
4	$138,000	$108,800	$    14,042	10.2 percent
5	$126,000	$96,800	$    11,402	9.0 percent
6	$132,000	$102,800	$    12,722	9.6 percent
Total	$761,000	$585,800	$    71,212	9.4 percent

Next, let’s look at what happens if John and Mary shift some of their higher-earning-year incomes to lower-income years.

Year	Income	After Std Deduction	Federal Income Tax	Effective Tax Rate
1	$124,300	$95,100	$    11,028	8.9 percent
2	$124,300	$95,100	$    11,028	8.9 percent
3	$124,300	$95,100	$    11,028	8.9 percent
4	$130,100	$100,900	$    12,304	9.5 percent
5	$126,000	$96,800	$    11,402	9.0 percent
6	$132,000	$102,800	$    12,722	9.6 percent
Total	$761,000	$585,800	$    69,512	9.1 percent

As you can see, the total income hasn’t changed, but the total taxes decreased. By simply moving some income across tax-year boundaries, the couple would have reduced their six-year total tax by $1,700. 

Obviously, by doing this over a lifetime of tax years and investing the tax savings, the couple could significantly increase their nest egg without affecting their lifestyle.

Some (Legal) Ways to Implement the Above

Using Individual Retirement Accounts (IRAs)

If you and your spouse are over 59.5, you’re each allowed to withdraw money from IRAs with no penalty. Withdrawals made from traditional IRAs (i.e., not Roth IRAs) would be added to your taxable income for that year.

Estes agrees, “Distributions in retirement depend on the situation. It may make sense to withdraw from traditional retirement accounts once someone is no longer subject to the 10% early withdrawal penalty.”

If your income isn’t too high to allow you to make deductible IRA contributions, you could each draw from an IRA in lower-income years and contribute that amount back to the IRA (up to the annual limit, currently $8,000 per person if over age 50) in a higher-income year, reducing that year’s taxable income. This means John and Mary could each draw $7,150 from a traditional IRA in years 1 and 3 and re-contribute that amount in years 2 and 4.

Using a Health Savings Account (HSA)

If you no longer have earned income and thus cannot contribute to an IRA, you may be able to use an HSA instead. This assumes you have an HSA-compliant health insurance plan.

Estes again, “Unlike IRA contributions, HSA contributions don’t require earned income. HSA contributions could help lower taxable income in a higher-income year – even in retirement! However, you have to be on a qualified high-deductible health plan to contribute. That might result in needing to hold more cash to afford the higher deductibles.

“Note that it may be prudent to delay withdrawals from HSAs and Roth accounts since those funds might not be taxed again (assuming certain conditions are met.)

“HSAs can be used for expenses later in life, like Medicare premiums and the medical portion of long-term care (LTC) expenses. Roth accounts could help with estate planning since heirs wouldn’t need to pay income taxes on the distributions.”

Another option for reducing taxes is to sell appreciated shares from a taxable account. Estes explains, “People nearing retirement may have a lot invested in individual stock that they’ve held for more than a year. Those shares are often in a taxable brokerage account and qualify for long-term capital gains (LTCG) tax treatment. Selling those could improve diversification and fund living expenses at low tax rates.”

Managing Business Expense Payment Timing

If you’re self-employed, you could ask vendors to allow you to delay payments due near the end of a lower-income year to the beginning of the following year, assuming you expect to have higher income in the latter year.

Similarly, you could opt to pay invoices due early in the next calendar year earlier than their due date, in the current year if you expect your income to be lower next year.

Managing Business Income Timing

The same is true for amounts your business is owed. You could ask clients to pay before December 31^st if you expect next year’s income to be higher than this year’s. Conversely, if you expect your income to decline, you could delay invoicing clients until January, pushing some of this year’s income to next year.

Optimizing Income Sources in Retirement

In retirement, you can manage your taxable income by tailoring the mix of accounts from which you draw money to cover your expenses.

Jason Gilbert, Founder and Managing Partner of RGA Investment Advisors explains, “When it comes to managing withdrawals from different retirement account types, it’s crucial to consider how timing and the type of account can significantly impact taxes. A tax-diversified approach, balancing withdrawals between taxable, tax-deferred, and tax-free accounts, helps manage tax liabilities effectively over time. By drawing from tax-deferred accounts while staying within desired tax brackets, retirees can optimize their overall tax efficiency, avoiding large tax hits in a single year and ensuring long-term benefits.

“Retirees should focus on flexibility when planning withdrawals. A combination of tax-deferred, tax-free, and taxable investments allows retirees to manage taxes, weather market volatility, and ensure their nest egg lasts as long as possible. Moreover, customizing withdrawals can help avoid unnecessary increases in Medicare premiums and reduce taxation on Social Security benefits.

“One of the most common mistakes I see clients make is delaying withdrawals from tax-deferred accounts for as long as possible to defer taxes. While that may work in the short term, it can result in higher Required Minimum Distributions (RMDs) later in life, which may push retirees into higher tax brackets, creating unexpected financial strain in those later years and increasing lifetime tax burden.

“Another important thing to consider is that there may come a point where continuing to contribute to tax-advantaged plans may no longer make sense. For those nearing retirement, especially if future withdrawals will push them into higher tax brackets, contributing to taxable accounts or using Roth conversions during low-income years can help improve long-term tax efficiency. This strategy can also mitigate the impact of large RMDs down the line.”

The Bottom Line

Our federal tax code was made progressive so that the burden of funding the government falls more heavily on those who make more and can thus afford higher taxes, and less heavily on those who make less and can’t afford the same tax rates.

While the above is why things are set up as they are, as an unintended consequence, this opens a legal way for you to reduce your lifetime tax burden by moving some taxable income from higher-income years to lower-income ones using some of the methods mentioned above. Consider seeking professional guidance from a financial advisor who can help you determine thoughtful strategies to reduce your lifetime tax.

Disclaimer: This article is intended for informational purposes only, and should not be considered financial advice. You should consult a financial professional before making any major financial decisions.