Learn how to Earn a Tax-Free Retirement Earnings of $ 100,000 or $ 200,000 per yr
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It’s a safe bet that no one – regardless of age – will be happy to hand over an income to the IRS.
However, in retirement, this can feel even more like a sting. Assuming you’ve gotten all of your earned income behind you, any amount owed Uncle Sam will come from your retirement income and savings – both of which are expected to fund your golden years for another two or even three decades as well.
The good news is that there are strategies out there to reduce what you end up paying in federal and maybe state taxes, which of course means more money stays with you. But getting there can take some work.
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“A lot of planning must be done to consistently generate tax-free income over the long term,” said certified financial planner Avani Ramnani, director of financial planning and wealth management at Francis Financial in New York.
For perspective, if you want your retirement assets to generate $ 100,000 per year of tax-free retirement income and you want to meet the 4% per year payout rule – generally a rate that can keep your money going for at least 30 years – you need at least a portfolio of $ 2.5 million.
Of course, your annual cash flow needs can be higher or lower than $ 100,000. Depending on the details of your situation, you may need to use a combination of strategies.
A Roth account
If you can save money on a Roth version of an individual retirement account or 401 (k) plan, there is a fairly simple way to set yourself up for tax-free income.
While your contributions are not tax deductible, as can be the case with a traditional IRA or 401 (k), distributions after age 59 are generally tax free.
“The best way to get tax-free income is to pay the taxes first – and the best way to do that is by contributing [a Roth account] throughout your working hours, “said CFP George Gagliardi, founder of Coromandel Wealth Management in Lexington, Massachusetts.
The maximum you can contribute to a Roth IRA in a year is $ 6,000 ($ 7,000 if you are 50 years or older). However, this amount will expire on income of $ 125,000 for a single taxpayer and $ 198,000 for married couples filing a joint tax return, and disappears when income is between $ 140,000 for singles and $ 208,000 for couples.
Roth 401 (k) accounts are more generous: there is no income cap, and you can contribute up to $ 19,500 through 2021 (plus an additional $ 6,500 if you’re 50 or older).
There are ways to bypass the Roth IRA’s income cap. For example, you could contribute to a traditional IRA and then convert the money into a Roth. Tax could be owed on the conversion, but you would not pay any tax on dividends later.
Health savings account
If you have access to a health savings account that can only be combined with a high deductible health insurance plan, you can use it to plan for tax-free income in retirement.
Unlike the flexible health spending account of the same name, you don’t have to spend HSA money within a certain period of time.
HSA contributions are tax-deductible, winnings in the account are tax-free, and withdrawals to pay for qualified medical expenses are also tax-free and punishable. (At 65 years of age, withdrawals can be used on anything without paying a penalty. However, if the money is used for non-medical expenses, it is taxable.)
You can donate $ 3,600 to an HSA in 2021 ($ 7,200 to family insurance). If you’re 55 or older, you can wager an additional $ 1,000.
These bonds are issued by states, counties, cities, and the like to fund public projects. And the interest you earn on so-called Munis is usually not subject to federal tax. If the bond is issued in your country of residence, it may also be tax-free at the state level.
“However, if you were to buy munis for a state you don’t live in, you’d have to pay state income tax on them,” said Francis Financial’s Ramnani.
For example, if you live in New York and buy bonds issued in California, you still have to pay state income tax on them, Ramnani said.
There may also be certain cases where Munis are subject to federal taxation. Hence, it is important to know before assuming that your earnings are tax free.
Benefit from long-term capital recovery rates
Any gain from an investment held for more than a year is considered long-term and is generally taxed as such. (Otherwise, it is taxed as ordinary income.) Same goes for qualifying dividends.
For long-term profits, the tax rate depends on your income. If you are a single tax advisor with income up to $ 40,000 ($ 80,000 for married couples filing together), the tax rate is 0%. If you can keep your income below these thresholds, those gains can be tax-free income.
Note, however, that taxes are only a consideration when it comes to retirement investment strategies.
“You have to think about portfolio allocation,” said Ramnani. “Are you well diversified and in line with your risk tolerance and goals?
“There can be competing goals or considerations.”
Life insurance or pensions
While permanent life insurance generally comes with much higher premiums than term life insurance, part of the reason is the savings aspect of these policies
“The idea is that you pay these high premiums and part of it goes to insurance and the other part into a bucket of savings and investments,” said Ramnani.
Depending on the specifics, these so-called present value life insurance policies can be used to generate tax-free retirement income, said CFP Michael Resnick, senior wealth management advisor at GCG Financial in Deerfield, Illinois.
“The distribution is a little more complex though, so caution is advised,” he said.
Similarly, retirement annuities can provide a stream of income. Generally, when you use an after-tax money to fund one, only the interest is taxable. There are many different types of annuities, however, and they can be more expensive than other sources of income. And if you give your money to the insurance company that sold you the annuity, it can be difficult to get it back after a short period of verification.
Depending on the contract, you can pay a so-called redemption fee if you no longer want the annuity or withdraw more from it than is permitted. This fee can be very high, especially in the first few years of the contract.
What about social security?
Depending on how much social security and other income you get, your benefits may be taxable – yet you may owe little to nothing to Uncle Sam.
The calculation basically involves adding half of your benefits to your adjusted gross income as well as non-taxable interest (i.e. Muni bonds). If that amount is $ 25,000 to $ 34,000 for a single taxpayer ($ 32,000 to $ 44,000 for married couples filing together) then 50% is taxable. It is not taxed below this income range. If it is above these amounts, 85% is taxable.
Even if the calculation results in a taxable amount, you can still subtract the standard deduction ($ 12,550 for singles and $ 25,100 for married couples in 2021). And if you’re 65 or older, get a higher standard deduction – an additional $ 1,700 for single registrants and $ 1,350 per person for married couples.
In other words, your deduction or deductions can bring your actual tax burden to or close to zero if you have taxable income.
There are of course other sources of income that might get in your way in retirement that are not taxable.
For example, if you are getting divorced, alimony (spousal support) is not taxable for the recipient if the divorce occurred after 2018. For example, if you receive a gift from, say, your parents, it is not taxable for you.
The same applies to life insurance revenues if you are the beneficiary of the policy. And any gain from the sale of your primary residence generally comes with an exclusion: up to $ 250,000 is tax exempt if you are an individual taxpayer and $ 500,000 for married couples filing together.