How To Plan The Tax For A Big One-Time Income Year Before Retirement

Severance, a legal settlement, a business sale, a large option or RSU exercise, a deferred compensation payout, and an inheritance tranche from a pre-tax account all share one feature: income that would normally arrive over several years lands in one. Federal income tax is progressive, so a single large year can climb through brackets that a level income stream would not touch. For 2026, a married couple filing jointly pays 22% on taxable income from $100,800 to $211,400, 24% to $403,550, 32% to $512,450, and 35% to $768,700 (IRS Rev. Proc. 2025-32). Taxable income is after the $32,200 joint standard deduction. Inherited traditional IRA money and deferred compensation are taxed as ordinary income, while the gain on a sale may be taxed at capital gains rates, so the type of income matters as much as the amount.

The bracket is only the first threshold. Several other lines key off the same income, and some are cliffs. Medicare surcharges (IRMAA) use modified adjusted gross income from two years earlier, so income in 2026 is what Medicare looks at when setting 2028 premiums, and income at 63 is the first year that counts for someone who turns 65. In 2026 the surcharges begin above $218,000 of MAGI for joint filers and $109,000 for single filers (CMS). Before 65, a household buying marketplace coverage loses the premium tax credit entirely above 400% of the federal poverty line, which for a two-person household and 2026 coverage is $84,600, and for 2026 there is no cap on repaying excess advance credits (HHS poverty guidelines; ACA rules). For 2027 coverage the cliff is based on the 2026 poverty guideline. The 3.8% net investment income tax (NIIT) applies to the lesser of net investment income or the amount your MAGI exceeds $250,000 for joint filers or $200,000 for single filers, and those thresholds are not indexed for inflation (CRS, IRC section 1411). Capital gains have their own steps: for 2026 the 0% rate ends at $98,900 of taxable income for joint filers and $49,450 for single filers, and the 15% rate ends at $613,700 and $545,500 (IRS Rev. Proc. 2025-32).

Not every lever works on every line, which is why the method matters more than any single tactic. Moving income to another year, or spreading it across years, can change the bracket, the capital gains rate, and the Medicare tier. Pre-tax contributions to a 401(k) lower AGI and MAGI, so they help on all of them. In 2026 the employee deferral limit is $24,500, and workers aged 60 to 63 can add a higher catch-up of $11,250 if the plan allows it (IRS, 2026 retirement plan limits). If prior-year wages from the employer were above $150,000 (the 2026 test uses 2025 W-2 Medicare wages), the catch-up portion must be made as a Roth contribution, which does not reduce AGI. Deferral from a payout also depends on the plan allowing deferral from severance or bonus pay. Charitable gifts are different. A donor-advised fund contribution or a bunched year of gifts lowers taxable income only if you itemize, and it does not reduce AGI, so it leaves the IRMAA, ACA, and NIIT thresholds where they were. Realized capital losses offset gains dollar for dollar and then up to $3,000 a year of ordinary income, with the remainder carried forward (IRS Topic 409 and Schedule D instructions).

Timing tools depend on the type of event, and some are decided long before the event. An installment sale lets a seller report gain as payments arrive, but depreciation recapture income from a business or rental sale is reported in the year of sale regardless (IRC section 453(i); IRS Publication 537). A deferred compensation plan pays on the schedule elected when the deferral was made, and changing the payout date later is tightly restricted, so the planning window is often an election form from years ago. Changing the timing of severance or deferred compensation that is subject to Section 409A can trigger additional tax, so the employer's counsel or plan administrator should confirm. Severance can sometimes be paid in installments or in January rather than December, but only if the employer agrees and the agreement is not yet signed. An option exercise can be split across tax years, and the retirement date itself is a lever: ending work in January rather than December changes how many months of wages stack under the payout.

A few moves usually make a spike year worse. A Roth conversion inside the event year is taxed on top of the pile and adds to the same MAGI that sets Medicare premiums. Whether it fits depends on the threshold that matters: in a year when income is lower than usual, or when the event already puts the year past a tier regardless, a conversion can cost less at the margin; where it would push the year over a cliff, the surrounding years are usually cheaper. Withholding is the second trap: lump sums are often withheld at a flat rate that has nothing to do with your actual bracket, and the penalty safe harbors for estimated tax are generally 90% of this year's tax or 100% of last year's, rising to 110% of last year's if last year's AGI was above $150,000 (IRS Publication 505), so a spike year can leave a large balance due. Splitting income across two years also is not free. In the illustration below, splitting a $300,000 payout in half saves about $3,000 of federal income tax, but it puts two Medicare lookback years at $300,000 of MAGI instead of one year at $450,000, so the Medicare tiers have to be modeled together with the income tax before choosing.

If you have a known event coming, the most useful first step is a two-column estimate: your normal year, and your normal year plus the event, using 2026 brackets and thresholds. A multi-year projection would show the federal tax, the Arizona tax (a flat 2.5% for 2026), the Medicare tier two years out, whether NIIT applies, and whether any ACA subsidy is lost. The gap between the columns is the real cost of the event, and it is rarely close to your average tax rate. Households often ask for the estimate before they sign, elect, exercise or close, because most of the useful choices are gone afterward.

Then decide which constraints are binding for your household. If you are 63 or older, Medicare tiers may matter more than the bracket. If you are under 65 and buy marketplace coverage, the $84,600 two-person cliff for 2026 may dominate. If the event is a sale of an investment or business, NIIT and capital gains steps matter. The right lever follows from which line is the problem. Pre-tax deferral helps most lines. Charitable bunching helps the income tax only. Timing helps when the event is flexible. A CPA or enrolled agent should run the final numbers for your return, because small facts such as the type of business interest or the plan document change the answer.

This is general education, not tax advice, and every figure in the illustration is hypothetical. Rules and thresholds change, and some of the planning tools above depend on plan documents or contract terms you have to check yourself.

• Estimating the tax at the average rate on last year's return, when the extra income is taxed at the marginal rate and can also trigger thresholds.
• Converting to Roth in the event year without testing it against the thresholds that matter, which can stack conversion income on top of the spike.
• Relying on a donor-advised fund to bring down IRMAA, ACA, or NIIT exposure, when a charitable deduction reduces taxable income but not AGI or MAGI.
• Assuming a flat withholding rate on a lump sum covers the real bill, then owing a large balance and an underpayment penalty in April.
• Looking only at this year's return and missing the Medicare lookback, which can raise premiums two years later and is hard to reverse.