Most financial advisors have a straightforward recommendation for managing and minimizing clients’ long-term tax liabilities: defer, defer, defer, avoid, avoid, avoid.
In the long run, it’s cheaper to defer those taxes and pay them with discounted future dollars. In the best of outcomes, the taxes can be avoided altogether.
Even so,
And for those who are not already in top tax brackets, deferring income too aggressively can cause future tax liabilities to increase by more than the discounting benefit of deferring them in the first place. In such scenarios, it’s often actually better to take advantage of lower current tax rates instead.

Harvesting the income accelerates the income from the future into the present to avoid the clustering effect that can drive up tax rates in the future.
Example 1. Dorothy is a 60-year-old widow who recently retired with $25,000/year in Social Security widow’s benefits and an inflation-adjusting survivorship pension of $45,000/year. In addition, she has a $300,000 brokerage account, and a $1.5M IRA. When
To manage the exposure, Dorothy decides to begin doing partial Roth conversions today of $90,000/year, all of which will be taxed in either her current 22% tax bracket or the 24% tax bracket. By repeating this process every year, Dorothy is able to substantially slow the growth of her pre-tax IRA to be ‘only’ $2.1M by age 72, which will result in an RMD of only $84,000… similar to her ongoing withdrawals during the interim years, and leaving her room to avoid ever being subjected to the 32% tax bracket in the future.

In essence, the value of income harvesting strategies is tax-rate arbitrage — the opportunity to shift income from higher-tax-rate years (in the future) to lower tax rate years (today). For income that was otherwise inevitably going to be recognized and taxable someday, triggering that income in lower tax rate years instead of higher tax rate years is effectively ‘free’ wealth creation (in that it doesn’t require taking on risk to generate the additional wealth, simply harvesting the available tax rates).
However, income harvesting strategies can be especially appealing in scenarios where the income itself can actually be harvested tax free (i.e., at a 0% tax rate).
For instance,

Example 2. Rose and Charlie retired early at age 55, living off $50,000/year of Charlie’s insurance trails (as a former insurance agent), plus $1,000/month from the dividends generated by a $400,000 brokerage account (which include $70,000 of embedded capital gains from recent market growth), while they wait for their Social Security benefits to begin (and wait to tap Charlie’s $300,000 IRA).
With a standard deduction of $24,800 in 2020, the couple’s ordinary income (after deductions) is only $50,000 – $24,800 = $25,200, placing the couple at the bottom end of the 12% tax bracket (which in 2020 runs from $19,750 to $80,250 of income after deductions). In fact, even with the additional $12,000/year of dividends, the couple’s income would still be in the 12% tax bracket… which means their (assumed-to-be-qualified) dividends are eligible for a 0% tax rate.
Accordingly, the couple chooses to proactively sell the most appreciated investments (a $90,000 ETF with a $50,000 cost basis) in their brokerage account to cause a $40,000 long-term capital gain. That brings their total income up to $50,000 + $12,000 + 40,000 – $24,800 = $77,200.
Because their total income after deductions is still below the $80,250 upper threshold for the 12% tax bracket, they will enjoy a 0% federal tax rate on both the qualified dividends and the $40,000 of long-term capital gains.

In the meantime, Rose and Charlie immediately buy back the ETF for the current $90,000 market value… effectively stepping up their cost basis from the prior $50,000 to $90,000 instead (
In addition, those who have tax deductions that exceed their total income – in essence, having negative income – can benefit from a 0% tax rate on Roth conversions or other ordinary income tax events (as increasing income from negative to zero still won’t owe any taxes on the additional income).
Example 3. Blanche is a 60-year-old widow who lives in a fully-paid-off Florida home, living primarily off her husband’s Social Security survivor benefits of $24,000/year, plus $500/month that she generates via tax-free municipal bond interest from a $300,000 brokerage account (while she leaves her $300,000 IRA untouched until the RMD phase more than a decade from now).
For income tax purposes, Blanche’s Social Security benefits are not taxable (as her Social Security provisional income is 50% x $24,000 + $6,000 (bond interest) = $18,000, well below the $25,000 threshold that triggers taxation of Social Security.
As a result, Blanche’s total taxable income is $0 (as her $24,000 of Social Security benefits are not taxable, nor is the $6,000/year of municipal bond interest), which means with a $12,400 standard deduction, Blanche’s taxable income will actually be -$12,400!
Accordingly, Blanche decides to do a $10,600 partial Roth conversion, which increases her income by $12,400 (as it causes her Social Security provisional income to rise to $28,600, causing $1,800 of her Social Security benefits to become taxable). Still, though, Blanche’s actual tax liability is not increased, as her standard deduction of $12,400 is still enough to offset the $12,400 of additional income.
Thus Blanche is able to move $10,600 from her IRA to a Roth IRA at a tax rate of 0%.

`Navigate the capital gains bump zone
There is obvious appeal to harvesting income at 0% rates, whether it occurs through Roth conversions or long-term capital gains. But there’s an important caveat to such strategies: It is not always possible to do both at the same time. The reason is 0% income can actually crowd out 0% capital gains or, at worst, trigger a phenomenon known as
The fundamental challenge: while capital gains that fall within the bottom two ordinary income tax brackets (i.e., 10% and 12%) may be eligible for 0% capital gains rates, it is still income for tax purposes.
Similarly, ordinary income that is offset by deductions is still income for tax purposes as well. Even as those types of income may benefit from 0% tax rates, eventually the 0% tax rate ends and additional income is subject to higher tax rates. (The ordinary income may surpass the available deductions and become taxable again, or the capital gains fall into higher tax brackets and are once again subject to the standard 15% tax rate on long-term capital gains.)
Importantly, income of one type can crowd out the favorable tax rates of the other. The Internal Revenue Code actually provides sequencing rules for how ordinary income and capital gains (and the prospective deductions that may offset them) will be applied to determine taxable income:
- Ordinary income
- Deductions applied against ordinary income
- Capital gains (stacked on top)
Which means in practice, engaging in partial Roth conversions (or in general, anything that generates additional ordinary income) reduces the amount of room that remains to capture 0% long-term capital gains.
Example 4. Sophia is a 75-year-old widow who receives $20,000/year of Social Security widow’s benefits, generates $6,000/year of tax-free municipal-bond income from her $200,000 portfolio, and has no other income outside of prospective withdrawals from her $400,000 IRA.
In Sophia’s situation, her Social Security benefits would not be taxable (as her Social Security provisional income does not exceed $24,000), nor would her municipal bond income be taxable, which after her $12,400 (standard deduction) + $1,300 (additional amount for being over age 65) = $13,700 of deductions would result in $13,700 of negative taxable income.
Sophia also has an old plot of family land that was originally purchased for next to nothing (i.e., a ‘zero’ cost basis), and is currently valued at $50,000, that she would like to sell and take advantage of the 0% capital gains rate… as even with an additional $50,000 of capital gains income, her total income after deductions would be -$13,700 + $50,000 = $36,300, less than the $40,125 threshold for the 12% tax bracket for ordinary income tax purposes.
However, Sophia has forgotten that she will also have a required minimum distribution this year (of approximately $17,500), which will more-than-absorb her negative taxable income, such that in reality, she will only have about $36,000 of capital gains potential at 0% rates (the excess of $40,125 over $17,500 – $13,700). In other words, Sophia’s ordinary-income RMD crowds out her room for 0% capital gains.
In addition, the combination of long-term capital gain and the RMD are both treated as “income” when determining how much of Sophia’s Social Security benefits will be taxable! In fact, Sophia’s provisional income for Social Security would be $20,000 x 50% + $6,000 (municipal bond income) + $17,500 (RMD) + $50,000 (long-term capital gain) = $83,500, more than enough to cause the maximum 85% of Sophia’s Social Security benefits to be taxable.
As a result, Sophia’s ordinary income would actually be $17,000 (taxable Social Security benefits) + $17,500 (RMD) – $13,700 = $20,800, leaving less than $20,000 of ‘room’ for Sophia’s capital gains to be eligible for 0% rates. Consequently, if Sophia had already taken the $50,000 capital gain, almost $30,000 of it would be taxable at 15% long-term capital gains rates instead!

As the above example of sequencing rules show, it’s extremely important to consider how ordinary income may crowd out the available room for 0% capital gains rates, or there is a risk that capital gains may unwittingly be claimed at higher-than-anticipated tax rates.
However, the situation can present an even more direct conflict for those who are outright eligible for both 0% ordinary income tax rates and 0% long-term capital gains.
Example 4b. Continuing the prior example, assume instead that Sophia was still 15 years younger, and decided to take advantage of her favorable tax situation, long before her Social Security benefits and RMDs would begin (and throw off her ability to maximize the value of the rules).
Thus instead, as a 60-year-old, Sophia decided to minimize her income for the current year – by drawing for spending solely from existing cash in her bank account, and her municipal bond income – and simply has -$12,400 of taxable income (her Standard Deduction), to leave room to take the $50,000 long-term capital gain on her family real estate sale.
The good news is that Sophia can harvest a $50,000 capital gain at 0% tax rates, a combination of $12,400 that is fully offset by her standard deduction, and the remaining $37,600 that is eligible for 0% long-term capital gains rates (as it’s below the $40,125 threshold).
However, the caveat is that Sophia didn’t effectively use her $12,400 standard deduction, as she didn’t ‘need’ the deduction to offset her capital gains to get 0% rates, and could have used it to offset some other ordinary income (e.g., a portion of her IRA withdrawals or a partial Roth conversion) that would otherwise be taxed at higher rates.
Accordingly, Sophia decides before the end of the year to do a $12,400 partial Roth conversion to absorb her standard deduction, correctly recognizing that the deduction will be applied (favorably) against her ordinary income first, while her long-term capital gain subsequently stacks on top.
However, the end result is that once the $50,000 long-term capital gain stacks on top of income of “just” $0 (and not -$12,400 with her standard deduction), Sophia’s total income of $50,000 will exceed the $40,125 threshold of the 12% tax bracket, resulting in the $9,875 excess triggering $1,481 of capital gains taxes at the 15% rate!
Consequently, even though Sophia’s $12,400 partial Roth conversion was eligible for a 0% tax rate, it caused $1,481 of indirect taxes anyway (an effective rate of almost 12%), as

In other words, while it’s possible to take advantage of 0% capital gains rates and 0% ordinary income tax rates, doing both at the same time can cause the favorable treatment of one to drive up the tax rates of the other.
Sequencing Roth conversions vs harvesting capital gains
The fact that harvesting ordinary income (e.g., via partial Roth conversions) can crowd out long-term capital gains means that in practice, it’s crucial to consider when each should take priority over the other (or not). This is relevant not only in situations where either or both may be eligible for 0% tax rates, but more generally in any situation where it may be appealing to harvest income at current tax rates to avoid potentially higher tax rates in the future (e.g., harvesting capital gains at 15% to avoid 18.8% or 23.8% rates in the future, or harvesting ordinary income at 22% or 24% rates to avoid 32%+ rates in the future).
As while

Because the underlying benefit of income-harvesting strategies is tax rate arbitrage, the optimal outcomes will generally be those that produce the largest change in tax rates by choosing to harvest the income today.
Accordingly, harvesting ordinary income at 0% tax rates is often the most appealing when available, as doing so will generally at least save 10% in ordinary income tax rates (the first tax bracket), but can potentially save at a 12%, 22%, 24%, 32%, 35%, or even 37% tax rate, depending on whatever the future tax rate was projected to be. Especially since a deduction today that results in negative income is permanently lost to the extent it’s not used (whereas capital gains eligible for 0% rates that are not used may at least be potentially harvested again in a future year where other income simply remains ‘low enough’ to remain in the bottom two tax brackets).
Next is to fill up the bottom two (10% and then 12%) tax brackets with 0% capital gains rates if available. As the next capital gains tax rate is 15% – which is a 15 percentage point increase – while ordinary income rates increase by just 10 percentage points to the next 22% ordinary income bracket. And, again, it’s hard to ever beat “0%” in the future (even if the tax laws someday change).
Once into the mid-tier tax brackets – 22% and 24% – the priority shifts again, as capital gains quickly become subject to an 18.8% tax bracket (at $200,000 of AGI for individuals, or $250,000 for married couples), leaving only a potential 5 percentage point increase at the top capital gains rates (23.8%), while ordinary income tax rates jump by 8 percentage points to the next (32%) tax bracket (and can climb further from there to 35% and 37%).
Especially since
On the other hand, for those in the 35% ordinary income tax bracket, the potential ordinary income rate increase is at least only 2 percentage points more (from 35%to 37%), while those subject to the 18.8% capital gains tax rate may soon face a 5 percentage point increase (to 23.8%). Which makes it more appealing to once again harvest capital gains at “just” 18.8% and avoid 23.8%. Until the upper end of the 35% bracket is reached (and 23.8% capital gains rates have already been breached), at which point any remaining room in the 35% tax bracket is the best deal remaining (albeit only a 2 percentage point savings before the top 37% tax bracket kicks in).

Prioritizing income versus capital gains harvesting
To figure out whether it’s better to harvest at current tax rates instead of future tax rates, the tax bracket alone is not the only determinant of
Relevant mitigating factors include:
* Social Security benefits. For those who receive Social Security benefits, the potential taxation of those benefits – which phases in based on income – is itself
* Medicare Part B and Part D premium surcharges. While the monthly premiums of Medicare Part B and Part D are not trivial, in reality, the typical consumer only pays approximately 25% of the underlying premium, with the remainder covered by the Federal government (funded primarily by the Medicare payroll tax). However,

* Net Investment Income Tax (NIIT). The Affordable Care Act first introduced
* (Changes In) state income taxation. While the primary focus of this discussion has been on the federal taxation of ordinary income and capital gains, the reality is that state tax rates matter, too. In general, though, state tax brackets tend to be flatter and less progressive – i.e., many states have a single flat tax rate, and for many others, it takes very little income to quickly reach a flat, top tax rate. And in many cases, state tax rates simply stack on top of existing Federal income taxes, which means the overall tax burden may be higher, but the relative benefit of accelerating (or deferring) income is equally relevant (i.e., state taxation wouldn’t actually change when/whether it’s better to harvest income, or capital gains, or neither, it simply happens to make the tax bill bigger in the end). Nonetheless, some states do have more progressive rates – where there again is an opportunity to accelerate income at today’s lower rates to avoid higher rates in the future. Though in other cases, an individual may be considering whether to relocate someday and move to another state with an entirely different tax rate altogether – which may make it appealing to harvest more now (i.e., to capture the income at a low-tax-rate state before moving to a state with a higher rate), or to completely unravel an otherwise-appealing harvesting strategy (i.e., saving 10 percentage points on federal taxes by accelerating income may be fully offset by the fact that the client’s state tax rate today is 10 percentage points higher than the one they plan to retire/relocate to in the future).
* Charitable contributions and step-up in basis at death (alternative means of receiving 0% capital gains rates). When it comes to long-term capital gains, harvesting gains within the bottom two tax brackets is not the only way to be eligible for 0% tax rates; long-term capital gains are also eliminated if held until death (receiving a step-up in basis), or when those appreciated investments are donated to charity (either directly, or
* Future tax rates of (retirement account) heirs. For relatively affluent retirees who don’t anticipate needing to use most or any of their retirement accounts beyond the moderate obligation of RMDs, most of the retirement account won’t actually be distributed at their tax rates at all. It will be distributed to their heirs at the beneficiaries’ tax rates instead. Which is important because it means the proper comparison of tax rates to evaluate potential tax rate arbitrage is not the current versus future rate of the account owner, but the account owner’s future tax rate compared to the heir’s tax rate in the future. This cross-generational tax rate comparison may make harvesting strategies even more appealing (e.g., if mass-affluent parents are leaving the funds to their children who are high-income doctors and lawyers), or less appealing (if ultra-high-net-worth parents are distributing the funds widely to children, grandchildren, and charities, at lower tax rates). In addition, state income tax rates may again play a role, where the biggest differential in tax rates may be the difference in state tax rates for heirs living in different states. Which means, again, that

ltimately, the benefit of income harvesting strategies is to take advantage of (relatively) lower tax rates today, to avoid the potential of higher tax rates in the future… especially since deferring income itself can cluster income into future years and cause higher tax rates.
However, the fact that ordinary income and capital gains each have their own tax rates, and their own tax bracket thresholds, means that a more nuanced approach is necessary to determine when and whether it is better to harvest ordinary income (e.g., via partial Roth conversions) or capital gains instead… based on an individual household’s own circumstances (and potential mitigating factors).
Fortunately, the fact that financial planners routinely make long-term retirement projections – which helps to show the trajectory of wealth accumulation, and the likely future tax brackets that a household will be subject to – makes it easier to figure out how likely it is that the household’s tax rates really will be higher in the future (making income harvesting appealing) or not.
Either way, though, it’s necessary to monitor the situation from year to year, as relatively moderate changes in the tax situation, or key mitigating factors, can materially alter whether it’s better to harvest ordinary income, or long-term capital gains instead.
Michael Kitces, MSFS, MTax, CFP, a Financial Planning contributing writer, is head of planning strategy for