5 Legal Ways To Get Tax-Free Income For Retirement

No one likes paying taxes.

Even with the supposed cuts of the Trump tax plan, I hear people complaining about how much taxes they are paying.

But with a little help there are a few ways to get tax-free retirement income.

I help people work toward reaching financial independence.

You know, the day work becomes an option.

The more taxes you will owe in retirement, the more assets you will need to have saved to fund your retirement.

Marriage can make some of these accounts even more valuable.

You may have heard of the marriage penalty, right?

For example, if you are retired and make more than $45,360 combined, 85% of your Social Security is taxable.

With this in mind, it can be advantageous to plan ahead for where your retirement assets will be held and how you will take withdrawals to help minimize the tax bite throughout your retirement years.

Here are five ways you can potentially earn tax-free income in retirement:

Roth IRA:  Think of this as the starter account. You can put in $5,500 per year. You won’t get a tax deduction when you put the money in but the money grows tax free and, most importantly, the money comes out tax free at retirement. While this may seem great to some, the problem is that most people will need to save more the $5,500 per year in order to reach their financial goals. Also, there are income limitations for who can contribute and how much. For example, only couples who earn up to a combined $189,000 each year and singles who make $135,000 or less are able to contribute to a Roth IRA.

If you contributed $5,500 per year from the time you were 22 until you reached the age of 65, and earned 10% each year, you would have more than $3.25 million dollars.

If you did that until you were 70, that number would jump to more than $5.25 million.

That’s magic of compounding interest at its best, which you could then turn into tax-free income.

Roth 401(k) or Roth 403(b):  This can be an excellent feature if your plan allows it. Similar to a Roth IRA, your growth and withdrawals are tax free. The difference is that you have the ability to contribute up to $18,500 per year, as well as a $6,000 catch up if you are 50 years of age or older). You will pay taxes on the contributions but there aren’t income restrictions for these plans.

Municipal Bonds and Funds:  This is the most investment specific of the options, so you will need to make sure these bonds fit your investment needs. The short overview is that income distributions from these bonds are not subject to federal income taxes, but they may still be subject to state income taxes.  For this reason, the interest rates these bonds pay is generally lower than that of taxable bonds. These bonds also have various investment and reinvestment risks, especially now that we are in a rising rate environment.

There is also the potential for default. A notable example of this occurred when the City of Detroit defaulted on its bond obligations. While income from these bonds may be tax free, your capital gains may still be taxable.

Health Savings Account (HSA):  This can be the triple whammy of tax-free income. You can get a tax deduction for contributions, the growth and, if taken properly, withdrawals are also tax free. You will need to have the appropriate type of health insurance in order to use this type of account, and investment options may be limited in some plans. This account is meant to be used to pay for current medical expenses, but you don’t have to pay for them now. You could hold the HSA until retirement with the fund growing and compounding along the way. You could then reimburse yourself for all the medical expenses you paid over the years (make sure to keep your receipts). Expenses can include Medicare premiums. The drawback is that you can only contribute $3,450 per year or $4,450 per year if you are 55 or older.

Cash Value Life Insurance:  I call this strategy the “Rich People Roth”. Most people don’t think of life insurance as part of their retirement plan and some believe it isn’t needed in retirement. However, this can be a wonderful tool to bridge the gap to financial freedom if you are married, have kids, have maxed out contributions to your other retirement account(s) or are in a high tax bracket. I won’t list all of the benefits of life insurance except that some policies have benefits you can enjoy before you die. Perhaps more importantly is the potential for tax-free income in retirement.

You should think of life insurance as another asset class for your retirement and tax planning.  Essentially, you can set up this account like a Roth IRA without income or contribution limits.

You won’t get a tax deduction for your premiums but the money will grow tax free.

If handled properly, it will come out tax free. Also, these accounts won’t incur IRS penalties for withdrawals before you reach 59 ½. This can be a huge bonus for people looking to retire early.

I don’t have a crystal ball but it wouldn’t surprise me if taxes went up in the future given the current deficit, underfunding of Social Security and longevity of today’s retirees.

Be proactive and develop a plan to reach your financial goals, including a comfortable retirement.  Having more options on how you get taxed on your retirement income will help make that a much easier task.


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