The Tax Valley: A Hidden Opportunity for Retirees

Many people approaching retirement think their tax bill will naturally go down once they stop working. While that might be true for a few years, it often doesn’t last. Once you start taking required minimum distributions (RMDs) from your retirement accounts and receiving Social Security, your taxable income can rise again.

But there’s a sweet spot before all that begins when retirees often experience temporarily lower income tax years. I had a client refer to it as the “tax valley,” which resonated with me and succinctly captures this unique window. It describes the years after retirement but before RMDs or Social Security benefits kick in. During these years, your income is often lower than usual, and that creates some valuable tax-planning opportunities. In order to understand these tax concepts, let’s begin with a refresher on some tax basics.

Know Your Income Types: Ordinary vs. Capital Gains

Understanding what kind of income you have is key to smart tax planning. Here’s a breakdown of the types of income you might encounter, and how they’re taxed:

Understanding the Basics: How Capital Gains Are Taxed

Capital gains come from selling capital investments—like stocks or mutual funds—for more than you paid for them. Short-term capital gains—from investments held less than one year—are taxed at the same rates as ordinary income. If you’ve held the investment for more than a year, it’s considered a long-term capital gain (LTCG), which gets taxed at lower rates than regular income, as highlighted in the chart above.

But here’s what many people don’t realize: capital gains don’t get taxed in a vacuum. They’re stacked on top of your ordinary income—wages, interest, or IRA withdrawals—to determine which capital gains tax brackets apply.

Why the Tax Valley Matters

During the tax valley, your ordinary income will likely be lower than while you were working. Additionally, deductions are applied first to ordinary income, further reducing your taxable income and giving you room to realize additional ordinary income or capital gains. You can consider a Roth IRA conversion while in a lower ordinary income tax bracket and/or sell appreciated investments and pay little or even zero tax on the gains. This article focuses on the opportunity to realize additional capital gains during the tax valley but we have two articles—Roth Conversions: One Proactive Measure During Bear Markets and Roth IRAs for Everyone—that describe Roth IRAs and the Roth IRA conversion in more detail if you are interested in learning more.

To see how this works in real life, let’s look at a few simplified examples of a retired couple’s income. Each scenario shows how the type and amount of income—ordinary versus long-term capital gains—in combination with their deductions affect how much tax they pay. These examples highlight how taking advantage of the tax valley can result in significant tax savings.

Scenario 1: All Gains Fall in the 0% Bracket

A retired couple, both age 66, has $60,000 in ordinary income from a small pension, non-qualified dividends, and some interest. They decide to sell some long-held stocks, realizing $80,000 in long-term capital gains. Their total income is $140,000.

The standard deduction in 2025 for a couple over age 65 is $34,700. In addition, those aged 65+ with Modified Adjusted Gross Income (MAGI) below $150,000 receive a temporary enhanced deduction* of $6,000 per taxpayer. Their combined standard and enhanced deductions total $46,700, bringing their taxable ordinary income to $13,300 (ordinary income of $60,000 less $46,700 deduction).

Since their taxable ordinary income utilizes only $13,300 of the $96,700 threshold for the 0% capital gains tax rate, they could realize up to $83,400 in long-term capital gains without incurring any tax. Therefore, they pay zero federal tax on their $80,000 gain.

Scenario 2: A Portion of Gains Taxed at 15%

Now let’s assume the same couple instead realizes $100,000 in long-term capital gains along with their $60,000 ordinary income, making their total income $160,000.

Their standard deduction remains $34,700, and their enhanced senior deduction is $10,800 (this deduction begins to phase out when MAGI exceeds $150,000). Their combined deduction in this scenario is $45,500, reducing their taxable ordinary income to $14,500.

So how is the $100,000 gain taxed?

$82,200 of the gain falls within the 0% tax bracket ($96,700 threshold less $14,500 taxable ordinary income). The remaining $17,800 of the $100,000 capital gain is taxed at 15%.

Scenario 3: All Gains Taxed at 15%

Finally, suppose this same couple has $140,000 in ordinary income and $80,000 in long-term capital gains, for a total income of $220,000.

After subtracting the standard deduction of $34,700 and enhanced senior deduction of $3,600—a combined deduction of $38,300—their taxable ordinary income is reduced to $101,700. Since this amount exceeds the $96,700 threshold for the 0% capital gains tax, all $80,000 of their gain is subject to the 15% tax rate.

What Makes This Possible?

Two key items make the tax valley so valuable:

1. Lower ordinary income after retirement.
2. Your standard or itemized deduction, which reduces your taxable income and gives you more room in the 0% or 15% capital gains brackets.

This opens the door for strategic actions, such as:

• Selling investments with gains while taxes are low
• Rebalancing your portfolio without a big tax hit
• Resetting cost basis on appreciated holdings

A Smart Time to Diversify

The tax valley can be a great time to start unwinding concentrated stock positions that have large unrealized gains.

Many clients come to us with stock they’ve held for years. Maybe it was gifted by a parent decades ago, acquired through an employee stock plan, or bought and held for a long time. Selling that stock often feels off-limits due to the potential tax bill.

But during the tax valley, when your income is temporarily lower, you may be able to sell a portion of that position and pay little or no tax on the gains. This creates an opportunity to diversify and reduce portfolio risk without triggering a painful tax hit.

Even if you can’t unwind the whole position in one year, you might be able to take advantage of the lower brackets over several years, gradually reducing the risk in your portfolio in a tax-efficient way.

It Doesn’t Last Forever

Once RMDs start at age 73—age 75 for those born in 1960 or later—or you start receiving Social Security, your taxable income usually increases, narrowing or even closing the window for 0% capital gains. That’s why it’s so important to think ahead. These early retirement years offer a unique chance to take control of your tax picture.

A Quick Word About Medicare Premiums

Before harvesting too many capital gains in one year, don’t forget about IRMAA (Income-Related Monthly Adjustment Amount)—the income-based surcharge on Medicare premiums. If your income crosses certain thresholds, you could end up paying higher Part B and Part D premiums for a full year, even if the extra income was just from realizing gains taxed at 0%.

Here’s the kicker: Medicare looks at your income from two years prior, so gains you realize in 2025 could impact your Medicare premiums in 2027.

This doesn’t mean you should avoid realizing gains. It just means we want to be strategic and avoid jumping over a threshold unless the long-term benefit outweighs the short-term cost.

Should You Do This?

Like most things in financial planning, the answer depends on your full situation: your income sources, investment mix, goals, and more. But if you’re in or approaching retirement, it’s worth having the conversation. We’d be happy to walk through the numbers with you and determine whether this strategy fits your overall plan.

* Introduced in the One Big Beautiful Bill Act, the temporary $6,000 enhanced deduction for those age 65+ begins to phase out when MAGI exceeds $75,000 for those filing single or $150,000 for married filing jointly and is available through 2028.

This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.