Picture this: you're a top earner who has spent years climbing the career ladder, accumulating increasing salaries, bonuses, and stock options, each year greater than the last. 

Then, life throws you a curveball. 

Maybe you’ve decided to take a sabbatical to travel the world, pursue a passion project, or simply recharge. 

Perhaps you’re navigating a career transition between jobs, launching a new business, or even facing an unexpected job loss. 

Whatever the reason, your income temporarily dips, leaving you in a low-income year—a more common scenario than you might think.

At first glance, this might seem like a setback. It might even seem terrifying if you’ve gotten used to the number in your bank account going up at a predictable rate. 

While less income often triggers healthy concerns about budgeting, saving, and meeting long-term financial goals, it also places many top earners in a scarcity mindset.

Uncomfortable or fearful by the ambiguity of lower income, many top earners may make financial decisions out of haste or otherwise spend some much-needed idle time in a state of tension.

But what if we reframed these low-income years as one of your life's most financially strategic periods? This isn’t just positive pep-talk; a dip in income can actually be a golden opportunity to speed up your tax optimization and long-term wealth building. 

In short, a low-income year isn't just a bump in the road— it's a quick detour to perks you’ll enjoy as soon as your next high-income year and as far as your retirement. 

The following guide explores the mindset around low-income years and a few strategies that should be at the top of your list. 

Understanding Your Low-Income Year Matrix

Abnormal income years can occur for various reasons, and recognizing where you may fall in the mix is the first step in proper planning. 

The most common scenario is a career transition, in which your end date and start date leave a brief (typically four to six months) gap. This can be due to either the term of a new job offer or the period between leaving and finding a new job. 

It’s become increasingly more common for high-earners to take intentional breaks, i.e., sabbaticals, from their careers for personal growth, travel, or family reasons. While it may be tempting to lop all financial activity into the “professional me” bucket, you can make a significant difference with a few relatively easy and low mental bandwidth-requiring tactics, which we’ll get into below. 

Scaling back work hours for personal reasons, like caregiving responsibilities or pursuing higher education, is also popular. 

Starting a new business is also a reason you may find your income lower than usual, and it also comes with unique considerations, as entrepreneurs may find themselves more strapped for cash and less willing to lock it into long-term retirement plans. 

Though this requires much greater planning complexity, retiring early requires calculated attention to income streams, tax treatments, and other cash-flowing initiatives like side hustles until retirement benefits kick in.

Understanding your situation is crucial, as it impacts which strategies will be most beneficial and how long you can expect the low-income period to last. Still, the financial aspects are only part of the equation. 

Equally important is navigating the psychological terrain of an abnormal income year, which can significantly influence your decision-making and overall well-being.

The Psychology of Abnormal Income Years

Time and again, top earners find themselves in a momentary low-income period, white-knuckled on the mental steering wheel, only to find themselves in another high-paying job months later, yearning for a vacation or some time off.

The mental aspect of considering any low-income year strategies and understanding the anatomy of abnormal income years can make all the difference. 

For starters, your level of certainty for the next period for which you anticipate higher income can help determine which strategies are the best fit or how aggressively you should pursue the ones that are. 

For example, the entrepreneur who boldly leaves a salaried job to start a new business with no revenue may want to prioritize liquidity and access to cash over long-term retirement account strategies.

In that case, it’s advisable to do things like use a tax withholding estimator (the IRS’s Tax Withholding Estimator is an excellent place to start) to ensure you’re not overpaying your estimated quarterly tax payments and shifting from a standardized deduction to an itemized deduction point of view. 

On the other hand, if you’ve planned for a sabbatical and orchestrated a lower living cost, you may also want to pursue the more active money movement strategies, such as Roth conversions outlined below. 

No matter the case, your emergency fund is the backbone of a mentally freeing low-income period. 

Roth Money Moves

One of the most potent moves during a low-income year involves Roth accounts because you'll likely be in a lower tax bracket, which means you’ll pay less in taxes on the converted amount. 

In a low-income year, your reduced earnings might make you eligible to contribute directly to a Roth IRA, with income limits that phase out as earnings increase. This opportunity to stash cash in a Roth IRA allows for tax-free growth and withdrawals—benefits that are hard to beat.

Verify the current income limits for Roth IRA contributions (for 2024, the phase-out begins at $138,000 for single filers and $218,000 for married couples filing jointly). If your income falls within the eligible range, you can maximize your direct Roth IRA contributions up to the 2024 limits: 7,000 if you're under 50 and $8,000 if you're 50 or older.

Beyond direct contributions, which are relatively limited, a Roth conversion can make a much more substantial impact. The “Backdoor Roth IRA” strategy involves converting funds from a traditional IRA or 401(k) to a Roth IRA. 

This strategy bypasses the income limits, allowing high earners a way to benefit from Roth accounts.

Keep in mind that every time you have to pay tax on the money, you convert it from a traditional account to a Roth at ordinary income rates. 

Suppose you’re in a 35% tax bracket during a typical year but in the 22% bracket during a low-income year. 

By converting $50,000 from your traditional IRA to a Roth IRA now, you’d pay $11,000 in taxes instead of $17,500, saving $6,500. 

By contributing to or converting to Roth accounts during a low-income year, you're essentially locking in your current low tax rate. 

All future growth and withdrawals from these Roth accounts will be tax-free, providing significant long-term tax savings. Over time, the tax-free growth in your Roth IRA could far exceed this upfront tax cost. 

Be sure to plan your Roth conversions carefully– converting too much at once could push you into a higher tax bracket. Advanced tax software and a financial planner can help you determine the optimal amount to convert and ensure you’re on the good side of the pro-rata rule, which could cause part of the conversion to be taxable if you have other traditional IRAs.

FAQs and Low-Income Year Nuances

Moves like Roth conversions can save you a fortune in taxes in a low-income year, but that’s not all.

The following list of low-income FAQs is like a VIP pass to the tax savings party, with a few dos and don’ts to be mindful of. 

1. Should I still contribute to my 401(k) or other retirement accounts if my income is low this year?

Absolutely. 

While it might seem counterintuitive to lock away money during a low-income year, continuing contributions—especially to accounts like Roth IRAs or 401(k)s with an employer match if available—can be incredibly advantageous. 

You’ll benefit from lower tax rates on Roth contributions, and if your employer matches contributions, that’s essentially free money.

However, just be mindful of your burn rate and cash needed to avoid liquidity crunches. 

2. Is it better to focus on paying down debt or investing during a low-income year?

It depends on the type of debt and your interest rates. If you have high-interest debt like credit cards, prioritize paying that down. However, if your debt carries a low interest rate (like a mortgage), you might be better off investing, mainly if you can do so in a tax-advantaged account during a year when your tax rate is lower.

3. How can I optimize my health insurance during a low-income year?

Low-income years can make you eligible for subsidies through the health insurance marketplace, significantly reducing your premiums. 

This might be an excellent time to reassess your coverage needs and explore plans that provide better value at a lower cost.

Better yet, contributing to an HSA to get a triple tax advantage if you have access to a high-deductible health plan.

4. How should I tap into my emergency fund during a low-income year?

Use your emergency fund judiciously. While it’s there to cover unforeseen expenses, a low-income year shouldn’t automatically trigger its use unless necessary. 

If you’re strategically planning and not facing an emergency, consider keeping your emergency fund intact and exploring other financial adjustments, such as from taxable accounts.

5.  Is this a good time to exercise my stock options before my income rebounds?

Low-income years are a prime time to exercise stock options, especially if they qualify as Incentive Stock Options (ISOs). By exercising now, you could reduce the impact of the Alternative Minimum Tax (AMT), which often surprises high earners. 

Be sure to calculate the tax implications carefully—this could be your stealth move to maximize gains without triggering a massive tax bill.

6. Is this the year to convert a portion of my traditional IRA to a Roth IRA, even if markets are down?

Converting during a market downturn in a low-income year is like shopping at a tax sale. You get to move assets over when their value is lower, meaning you pay less tax now, and when they rebound, all that growth happens tax-free in your Roth. 

If the timing aligns, pairing a conversion when the market is on sale and your income is down is a great play. 

7. Should I strategically realize capital gains this year to reset my cost basis?

You’ve heard of tax loss harvesting, but how about actually realizing some gains?

In a low-income year, you might be in a lower capital gains tax bracket, potentially even 0%. 

Harvesting gains now allow you to reset the cost basis on appreciated assets without a hefty tax hit. 

This could set you up for more tax-efficient withdrawals, especially when you’re back in a higher bracket. 

8. Should I prepay deductible expenses like property taxes or mortgage interest to maximize deductions?

Paying deductible expenses can be a good idea, but it comes with a caveat. If you’re itemizing deductions this year, prepaying deductible expenses like property taxes or mortgage interest could push you over the standard deduction threshold, giving you a bigger tax break. 

It’s a tax-time magic trick: shift deductions into a low-income year when they’re worth more to you.

9. How about other income-smoothing strategies, like deferring bonuses or accelerating income?

It depends on your crystal ball. 

For instance, if you still have a salaried position and the option to smooth your income, you can use this period to your advantage. 

If you expect your income to rebound significantly next year, accelerating income into this low-income year could keep you in a lower bracket. 

Conversely, deferring income until next year might make sense if you expect deductions or losses that can offset it. 

This high-level tax Tetris requires knowing when to slot income into the correct year, and working with a financial planner can be a big help. 

10. How should I reassess my investment in real estate or other passive income sources during a low-income year?

When earning less, it’s ideal to reassess the performance of your real estate or other passive income sources, particularly from a tax perspective. 

The Qualified Business Income (QBI) deduction allows you to deduct up to 20% of your qualified business income, which can include certain types of rental income. 

This deduction is phased out at higher income levels, so during a low-income year, you can claim more than you would otherwise.

Additionally, consider conducting a cost segregation study on your real estate properties. 

This study breaks down the components of your property (like lighting, landscaping, and fixtures) into different asset classes that can be depreciated more quickly. 

Accelerating depreciation means you can take more significant deductions now, reducing your taxable income even further in a year when you’re already in a lower bracket. 

Though this may be more beneficial in a higher-income year when the reduction may make a bigger 1:1 impact if you find yourself idle during a lower-income year, this can be an excellent moment to explore the strategy. 

The Low-Income Year Mentality

Tax optimization is like a never-ending game of tug-of-war—on one side, you’ve got your hard-earned money; on the other, the tax man is just waiting to snatch a chunk of it. 

Some of this tax dance is as predictable as your morning coffee: every year, Uncle Sam will take his cut from your ordinary income, like your salary, at ordinary income tax rates.

But here’s where it gets interesting: tax-advantaged accounts can stretch that tax bill years, even decades, into the future, turning today’s financial moves into tomorrow’s savings.

And then there’s the whole tango between long-term and short-term capital gains—yet another layer in this intricate tax optimization dance.

Due to varying tax rates, a low-income year is a rare opportunity in a top-earning career to perform savvy financial maneuvers at a fraction of what they’d cost in higher-income years. It’s also an opportunity to access strategies you’d otherwise be barred from due to high-income thresholds. 

However, remember that while some strategies may reduce your tax bill further in a low-income year, they may be better left for higher-income years, when the dollars saved will make a dollar-for-dollar more significant impact due to your higher tax rates. 

The real genius lies in the nuances. It’s not just about the big moves like Roth conversions; it’s also about those lesser-known strategies that can make a world of difference.

Making Cents of Lower Income Years

Let’s face it: In the fast-paced world of high-earning professionals, it’s easy to view income fluctuations as a problem to be managed rather than an opportunity to be seized.

Whether it's due to a career transition, personal choice, or unforeseen circumstances, low-income years are excellent opportunities to take advantage of the lower income thresholds for financial planning and tax optimization purposes, doing maneuvers that could cost you upwards of double in higher-income years. 

Critically, abnormal income years allow you to convert larger sums while staying in a lower tax bracket, which can be a gift to your future self when you’re in a higher tax bracket. 

This article focuses primarily on Roth conversions and similar topics, but it also addresses a host of nuanced, frequently asked questions that illuminate the often-overlooked corners of a complete financial picture. 

With the proper support and preparation, a low-income year is more of a strategic game of financial jiujitsu than a setback.