How To Get Entirely Tax Free Retirement Income

And Traditional Ira Distributions

There is an ideal balance to have in your pre-tax accounts such as 401s and IRAs. By arranging your affairs properly in the other areas of your retirement strategy , and through the wise use of the standard deduction, you can have your pre-tax accounts generate a fourth stream of tax-free income. So long as you have shifted or converted enough of your pre-tax assets to tax-free strategies such that the RMD of your pre-tax accounts will not exceed the standard deduction, you can enjoy this income stream tax-free as well. Consideration regarding provisional income thresholds should also be had in determining how much of your pre-tax assets to convert or shift.

Life Insurance Retirement Plans

A LIRP is a type of cash value life insurance that has been stripped down and optimized to function as a retirement tool, shedding many of the expenses that plague traditional permanent life insurance options .

A properly structured Life Insurance Retirement Plan allows for after-tax contributions and tax-free growth and distributions. There have some significant advantages:

• No contribution limits
• No age 59 ½ restrictions
• Highly liquidity
• Term insurance death benefit that doubles as long-term care if needed
• Locking in of annual gains
• Protection against market losses
• Distributions do not trigger taxes on social security benefits
• Specifically engineered for income production

The drawback to a LIRP is that you must be decently healthy. Many normal health challenges that come with aging are acceptable, but if someone has had significant health challenges, a LIRP may not be the right answer.

For a more in depth review of this potentially powerful tool , please visit or blog post Tax-free RetirementUtilizing a LIRP As Part of a Tax-free Retirement.

A Roth IRA and a LIRP can make a powerful combination of tax-free streams of income.

How Much Is Enough When It Comes To Retirement

The number that’s being buzzed about in the retirement-planning world is 135 percent. That’s the new “replacement ratio”basically the percentage of pre-retirement income that one needs to earn yearly to maintain a consistent level of comfort in retirement.

The long regarded number for one’s replacement-ratio was much lowera mere 75 percent of income s, Social Security, IRAs, and earned income).

Dan Ariely, a professor of economics and behavioral finance at Duke University, is the author of a 2011 study that blew the lid off many Americans’ retirement plans. His study caused some backlash within the finance community, but the bottom line is that you can never be too well-prepared for retirement, whether you’ve planned for 75 or 135 percent.

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Critical Choices: Where To Sock Away Savings

It’s tough to generalize retirement-savings plans for a broad audience, but it’s clear that Americans do not excel at saving. In 2006, the Employee Benefits Research Institute reported that more than 50 percent of workers between the ages of 45 and 54 had less than $50,000 saved for retirement. A 2007 Fidelity Investments study revealed the average baby boomer has prepared to replace only 62 percent of current income in retirementand that includes Social Security and pension income.

Christopher Kimball Financial Services is a Lakewood, Washington-based firm that specializes in retirement planning. Founder Christopher Kimball says, “A good rule of thumb is: If you want to withdraw $40,000 to $50,000 per year, you’ll need roughly $1 million saved.”

Another key, in financial-planning terms is to have “buckets” prepared well in advance of retirement.

“Everyone should have three buckets: Savings, taxable investments , and a tax-free bucket ,” says retirement and estate-planning expert Scott Cramer, president of Cramer & Rauchegger in Winter Park, Florida.

Kimball agrees: “Diversifying not only in what investments you choose, but also what kind of tax treatment those investments receive, is crucial.”

Generally, with tax-qualified, tax-deferred retirement plans such as a traditional IRA, 401, or 403, all money taken out is treated as taxable income.

Grow Your Health Savings Account

Another way to build up your nest egg is with a Health Savings Account. Not to be confused with a health flexible spending account, an HSA allows you to set aside tax-free money for qualifying healthcare expenses. This includes anything from over-the-counter treatments such as eye drops or aspirin to larger medical expenses such as hospital services, long-term care payments, prescriptions, and vision and dental care.

People over the age of 65 can even spend the money on non-medical expenses without a penalty fee . HSA contributions, withdrawals, and gains are all tax-deductible, meaning they are primarily designed to give tax breaks to people with high-deductible health insurance plans. Nonetheless, they can also make for strong retirement planning assets. The caveat to this method is having access to one, as an HSA can only be paired with a high-deductible health plan.

Plus, the balance of an HSA carries over each year, and most providers offer investment options to help you grow your savings. With no required minimum distribution, you can leave the account untouched and let the growth accumulate. Currently, you are able to contribute $3,600 or $7,200 for family coverage to an HSA. For those over the age of 55, you can allocate an additional $1,000.

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How To Get Entirely Tax Free Retirement Income

Here are six ways you can potentially earn tax-free income in retirement.

What states have no pension taxes?

• No-Tax States for Government Pensions. The type of pension you have determines if a state taxes it. Eight states with income tax do not make retired military personnel pay it on their pensions: Alabama, Kansas, Massachusetts, New Jersey, Hawaii, Wisconsin, Louisiana and Michigan. Arizona and Hawaii dont tax state or local government pensions.

Roth Ira Or Roth 401 Withdrawals

Traditional 401 plans and traditional IRAs allow you to avoid paying income tax now. You get a tax deduction for your contributions. The money even grows tax-free.

Unfortunately, they require paying taxes when you withdraw the money from the retirement account. These are called tax-deferred retirement accounts.

No one knows what income tax rates will be in the future. This puts a significant amount of uncertainty in your retirement plans.

Federal income tax rates are currently relatively low on a historical basis. They could increase in the future. If it does, it could leave you with less retirement income than youre expecting.

If you want tax-free retirement income, youll need to use a different version of these retirement accounts.

Roth 401 retirement plans and Roth IRAs require you to pay taxes on the money you contribute to the account.

The best part, however:

Once the money is in the account, the earnings on the investments grow tax-free.

When you eventually reach retirement age, you can withdraw both the original contributions and the earnings without paying federal income taxes on them.

This takes quite a bit of uncertainty out of your retirement planning.

The money you see in your account will be yours. You wont have to worry about paying federal income taxes on it.

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What About Social Security

Depending on how much you receive from Social Security and your other income, your benefits may be subject to tax yet you may still be able to owe little to nothing to Uncle Sam.

The calculation basically involves adding one-half of your benefits to your adjusted gross income, as well as nontaxable interest . If that amount is $25,000 to $34,000 for a single tax filer , then 50% is taxable. Below that range of income, it’s not taxed if it’s above those amounts, 85% is taxable.

However, even if the calculation results in an amount that is subject to tax, you’d still get to subtract the standard deduction from that. And, if you are at least age 65, you get a bigger standard deduction an extra $1,700 for single filers and $1,350 per person for married couples.

In other words, your deduction or deductions may bring your actual tax burden down to zero or close to it if you do have income that’s taxed.

What Is A Tax

A tax-free retirement account or TFRA is a type of long-term investment plan thats designed to help minimize taxes on retirement income. A TFRA retirement account is not a qualified plan so it doesnt follow the same rules as a 401. But it can offer both tax benefits and risk protection for investors. Breaking down how a tax-free retirement account works can help you to decide if this strategy may be right for you. A financial advisor may also be able to help you determine if a TFRA is right for you. Try using SmartAssets free advisor matching tool today.

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Whole Life Or Permanent Life Insurance

If you have a whole life or permanent life insurance policy, there is another way to get cash from the policy.

These policies generally build cash value over time. Insurers often let you borrow against this cash value or cash out the policy altogether.

As long as the money you cash out is less than the premiums youve paid, the money is usually income tax-free.

Any money taken out in excess of the premiums you paid is considered taxable income.

If you cash out the policy in full, the policy will no longer be in effect. This means you wont get a death benefit if the insured person dies.

Be very careful before deciding to cash out a whole or permanent life insurance policy.

Of course:

There are exceptions and other rules for specific situations. Check with your tax professional to make sure your policy works as you expect for income tax purposes.

The Golden Years Guide To Tax

OVERVIEW

The earlier you begin socking away savings, the much better off you’ll be in your “golden years.” By using some tax tips, you can end up paying little or no taxes after you retire.

For information on the third coronavirus relief package, please visit our American Rescue Plan: What Does it Mean for You and a Third Stimulus Check blog post.

It’s natural to put off retirement planningthere are families to raise, college tuition to pay, and life to be lived. However, the earlier you begin socking away savings, the much better off you’ll be in your “golden years.” Using some tax tips, you can end up paying little or no taxes after you retire. It’s a very good reason to make solid planning a priorityno matter how old you are.

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Topic No 410 Pensions And Annuities

• Other Languages

If you receive retirement benefits in the form of pension or annuity payments from a qualified employer retirement plan, all or some portion of the amounts you receive may be taxable unless the payment is a qualified distribution from a designated Roth account.

This topic doesn’t cover the taxation of social security and equivalent railroad retirement benefits. For information about tax on those benefits, refer to Topic No. 423 and Are My Social Security or Railroad Retirement Tier I Benefits Taxable?

Federal Taxes On Retirement Accounts

If you have a traditional 401 or traditional IRA, the IRS generally requires that you begin to take annual required minimum distributions during the year in which you turn 72 years old. Withdrawals from those accounts are generally taxed as ordinary income. The larger your savings in the account, the larger the withdrawal requirements, which could push you into a higher tax bracket than expected.

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Using A Tax Loss To Get A Tax Break

A hypothetical investor who realized $20,000 in short-term capital gains and has $25,000 in unrealized capital losses, could use tax-loss harvesting to cut down her tax bill.

Assumes a 32% combined federal/state marginal income tax bracket, with short-term capital gains taxed at the ordinary income tax rates. The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product and the example does not reflect the effects of fees.

Types Of Pension Plans

Various pension plans are available in India. All of them can be categorized into the following:

1) Sponsored by Insurer

The premium paid for these plans is lent to corporates or banks by the insurer. So, these plans earn income only from the debt securities. Risk-averse people should invest in a sponsored pension plan. You can choose from 2 types of annuity plans here:

a) Deferred Annuity Plan

Under this scheme, you can pay regular premiums until your retirement. Then, post-retirement, you get a regular stream of income to sustain your expenses.

b) Immediate Annuity Plan

You are required to pay a lumpsum premium under this scheme. Subsequently, you can enjoy the monthly pension payments immediately after.

2) Unit Linked Pension Plans

These plans invest your premium money mainly in equity. They also invest a portion of these funds in debt markets to gain stability. Having said that, higher chances of returns imply a higher risk due to stock market exposure. Therefore, investors having a higher risk appetite should opt for these plans.

3) National Pension Scheme

In the wake of the success of private pension plans, the Govt. of India introduced a state-sponsored pension plan in 2004. You receive units as per the NAV of the fund that you choose to invest in. Post-retirement, you are allowed to withdraw 60% of the corpus upfront and purchase an annuity scheme with the remaining 40%.

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Social Security Income Tax

If your taxable retirement income is small enough, you can receive your Social Security benefits tax-free. I am going to go out on a limb here and say unless you have substantial tax-free income here, you do want to be taxed on your Social Security. The reason is that if your total income is low enough for your Social Security to not be taxable, you are likely sitting near the poverty line.

In 2022, at an income of just $25,000 or $32,000 , your Social Security benefits begin to be taxed. Keep in mind this includes your Social Security checks as well as all other taxable retirement income.

How Does A Tfra Retirement Account Work

A tax-free retirement account or Section 7702 plan is funded through a permanent cash value life insurance policy. Depending on how a TFRA is structured, this may be a whole life policy, variable life policy or universal life insurance policy.

A TFRA is funded with after-tax dollars, similar to the way youd fund a Roth IRA. Cash value in the policy grows tax-deferred and policy owners can take out tax-free loans from that cash value during their lifetime. The amount of cash value that accrues inside the policy can depend on the underlying investment strategy.

Since TFRA retirement accounts are not qualified plans, theyre not subject to the same tax rules as those plans. For example, theres no 10% early withdrawal penalty to worry about if you need to take funds out of the policy prior to age 59 ½ as there would be with a 401 or IRA. Income generated by the policy is also tax-free.

TFRAs can be used to plan for retirement alongside other qualified retirement plans but they cant be commingled. For example, if youre changing jobs and want to roll over your 401, you wouldnt be able to do a direct rollover to the policy. You could, however, roll the funds over into your new employers 401 or into an IRA.

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Keep The Tax Bite During Conversion To A Minimum

For anyone converting savings that have grown over time to a Roth, keep in mind the amount you convert will be added to your annual taxable income. Consequently, it will bump up your tax bill for that year.

And if you convert a very large sum all at once, it could push you into a higher federal tax bracket.

So you may minimize your tax bill if instead you opt to convert the money in smaller chunks over a few years, Schultz noted.

Either way, be sure you have enough liquid funds on hand to pay the taxes youll owe on the conversion.

What This Means For Early Retirees

Let’s consider a couple that’s 50 years old. They’ve been putting money away in their 401s and traditional IRAs for their entire working lives. That has allowed them to build up a substantial nest egg — say $600,000.

But because they lived a disciplined lifestyle that eschewed things like buying as much house as they could afford, driving brand-new cars, and sending their kids to the most expensive colleges on Earth, they can live comfortably on $40,000 per year now that the kids are gone.

The couple knows that once they are 62, they’ll be able to have all of their needs met by a combination of Social Security and their nest egg. They’ll also be able to start getting that money from retirement accounts starting at age 59-1/2 years old. They just need to bridge the gap between when they retire and when they can tap those sources of income.

They did this by investing any leftover money they had — after contributing to their 401 and IRA — in a regular brokerage account. They bought stocks of solid companies with durable competitive advantages and, in many cases, dividends. In some years they’d have to pay taxes on those dividends while they were working, but not in all years.

Once they quit their jobs, they’ll get the requisite $40,000 in annual income by collecting dividend payments and selling some stocks — and they’ll never pay taxes on any of it.

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