A key goal in any retirement plan is to minimize expenses so your assets last as long as possible. There are a number of cost-cutting measures you can take in retirement, such as downsizing to a smaller home or reducing your amount of discretionary spending on things like dining out and shopping.
Another major expense to consider is taxes. As a retiree, you may have to pay taxes on everything from Social Security to pension benefits to retirement account distributions and more. Those taxes can reduce your spendable income and impact your standard of living.
Fortunately, there are steps you can take to help protect your financial stability and minimize your tax exposure. One potential action step is to maximize your tax-free income. Below are four tools you can use to generate sources of tax-free income in retirement and limit your tax liability:
A Roth IRA is a popular retirement savings tool that can also be used to generate a tax-free income stream. The Roth IRA shares similarities with the traditional IRA, but there are also important differences between the two. Both offer tax-deferred growth, but there are important differences between the two. While a traditional IRA allows you to make tax-deductible contributions, you will have to pay taxes on all distributions from the account in retirement.
With a Roth IRA, your upfront contributions aren’t deductible, but you are able to withdraw your funds tax-free after age 59½. Essentially, with a Roth IRA you give up tax benefits today in exchange for tax-free income in the future.
If you have a traditional IRA but would prefer to have a Roth, you can do a Roth conversion. That’s a process in which you transfer your funds from the traditional IRA into a Roth IRA. You will have to pay taxes on the converted amount, but you will create a source of tax-free income in the future.
Cash Value Life Insurance
Also known as permanent insurance, cash value life insurance is another potential source of tax-free retirement income. Cash value life insurance is available in several different policy types, including whole life, universal, and variable. Each has its own unique features and benefits, but all of them allow the cash value of your policy to grow tax-deferred.
The unique feature of permanent life insurance is that it allows you to withdraw your premium payments tax-free. Once you withdraw all premiums, you can take the growth out via tax-free loans. If the loans aren’t repaid during your lifetime, the balance is simply deducted from the death benefit before it is paid to your beneficiaries.
A municipal bond is a debt instrument issued by a state government, municipality, or other nonprofit entity, such as a hospital or public works department. These organizations issue municipal bonds to raise money to fund operations or projects. The interest on municipal bonds is usually tax-free.
There are a couple of approaches you can take when purchasing this type of bond. You can buy individual bonds, or there’s the option of buying mutual funds that specialize in municipal bonds. While municipal bond interest is tax-free, if you sell a bond for a gain, that gain could be taxable.
Health Savings Account (HSA)
An HSA doesn’t create general income that can be used for any purpose, but it’s still a valuable resource that offers tax-advantaged income to pay medical expenses. It could be a valuable resource after you stop working, as health care is often a substantial retirement expense.
It allows you to make deductible contributions and grow your investments in a tax-deferred account. You can then make tax-free withdrawals from the account to pay for qualified medical expenses. This can potentially be of major benefit, as health care costs can be significant in retirement.
Ready to plan your tax-free retirement? Let’s talk about it. Contact us at Carstens Financial Group. We can help you analyze your needs and develop a strategy. Let’s connect soon.
This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting or specific advice for your situation. By providing your information, you give consent to be contacted about the possible sale of an insurance or annuity product. This information has been provided by a Licensed Insurance Professional and does not necessarily represent the views of the presenting insurance professional. The statements and opinions expressed are those of the author and are subject to change at any time. All information is believed to be from reliable sources; however, presenting insurance professional makes no representation as to its completeness or accuracy. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.
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