6 Ways To Get More Tax-Free Income In Retirement


I’ve never met anyone who loves paying more taxes on their retirement income. Building a retirement income you won’t outlive is hard enough without overpaying your taxes. Any strategy that helps you increase the amount of your tax-free retirement income will help minimize these two challenges.

As a tax planning-focused Certified Financial Plannerä, I love helping people stay on track to reach financial freedom. Financial security can help you live a happier, healthier, and wealthier retirement. The larger your retirement tax burden, the more income-producing assets (cash, investments, real estate, 401(k), Cash Balance Pension Plans, etc.) you will need to accumulate to maintain your standard of living as you age. It will also likely increase the investing risks you must take with the assets accumulated over your lifetime.

Here Are 6 Tax Planning Strategies To Get More Tax-Free Income

Contribute To Your Roth IRA

You can think of the Roth IRA as the starter retirement account. You can contribute up to $7,000 in 2024 ($8,000 if you are 50 or older). Your contributions usually have no tax deductions, and your Roth IRA will grow tax-free. Most importantly, the money comes out as tax-free retirement income. While this may seem like a small amount to save each year, the problem is that most of you will need to save substantially more than $7,000 per year to reach financial freedom and other financial goals. Also, there are income limitations on who can contribute and how much.

If you contributed $7,000 per year, from when you were 22 years old until you reached age 65 and earned a 10% return each year, you would have more than $4.14 million. If you worked a little longer and saved until age 70, that number would jump to over $6.72 million. That’s the magic of compounding interest at its finest. Think of how much tax-free retirement income you could draw from a $6.72 million Roth IRA.

Set Up Your Roth 401(k) Or Roth 403(b) Now

If you want even more tax-free income than a Roth IRA can deliver, consider contributing to a Roth 401(k) or Roth 403(b). Your employer will need to offer this option. Self-employed people can set up their own Roth Solo 401(k).

A Roth 403(b) or Roth 401(k) has tax benefits similar to a Roth IRA; your growth and withdrawals are tax-free. The difference is that you can contribute up to $23,000 per year, plus a $7,500 catch-up contribution if you are 50 or older, for 2024. You will pay taxes on the contributions, but these plans have no income restrictions.

Mega Backdoor Roth Contributions

If you are a supersaver and have already maxed out your Roth IRA or Roth 401(k), you may want to check out the Mega Backdoor Roth. With this strategy to get more tax-free income, you may be able to make additional after-tax contributions to your 401(k). This tax-planning strategy could help you contribute up to $69,000 annually into your 401(k).

Tax-Free Income From Municipal Bonds And Funds

Bond interest rates have jumped recently, making municipal bond investments more appealing. The tax-free income from municipal bonds may make them more competitive with their corporate bond counterparts.

The short overview of tax-free income from municipal bonds is that the distribution from these bonds (or bond funds) is not subject to federal income taxes but may still be subject to state income taxes. For this reason, the interest rates these bonds pay are generally lower than those of taxable bonds. These bonds also have various investment and reinvestment risks, especially in a rising rate environment.

There is also the potential for default with municipal bonds. A notable example 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 when buying or selling bonds.

Optimize Your Health Savings Account For Tax-Free Income

A Health Savings Account (HSA) can be the valuable triple whammy for tax-free income. Investing in an HSA can be even more tax-efficient than a Roth IRA. First, you can get a tax deduction for contributions to your HSA each year. Second, the growth of investments within an HSA is tax-free. Third, when taken correctly, withdrawals from an HSA are also tax-free. You will need the appropriate type of high-deductible health insurance plan to be eligible to contribute to this type of account, and some plans may limit investment options.

HSAs are meant to pay for current medical expenses, but you don’t have to use the account for those costs now. You could hold the HSA until retirement, with the fund growing and compounding. You could then reimburse yourself for all the medical expenses you paid over the years (keep your receipts). Expenses can include Medicare premiums. The drawback is that in 2024, you can only contribute $4,150 per year. Couples can contribute $8,300, and those 55 and older can make an additional $1,000 catch-up contribution. These amounts are adjusted each year.

Tax-Free Income From Cash Value Life Insurance

The strategy for maximizing tax-free income from life insurance has been called the “Rich People Roth.” Most people don’t think of life insurance as part of their retirement plan; some believe it isn’t needed for those already retired. However, cash value life insurance can be an excellent 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 life insurance benefits except that some policies have benefits you can enjoy before you die. More importantly, perhaps, is the potential for tax-free income in retirement. You should only consider this strategy once you have maxed out your other retirement accounts, especially if you don’t need large amounts of life insurance.

The Rich Person Roth, a tax-planning strategy, is often sold to people to earn a hefty commission. So, ensure you work with a fiduciary financial planner before buying a life insurance policy for the tax benefits, especially if you are not already maximizing your contributions to the various other retirement accounts available to you that likely have lower fees and should be more beneficial for your wealth building.

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

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