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September 7, 2021
September 15, 2021
Here are strategies you can implement to minimize or eliminate your tax bill, which translates into more money staying with you. This involves some work in advance. “To generate, on a regular basis, tax-free income over a long period of time, you have to put a lot of planning in place,” said certified financial planner Avani Ramnani, managing director at Francis Financial in New York.
For example, if you want your retirement savings to generate $100,000 a year in tax-free retirement income, and you want to adhere to the so-called 4%-per-year withdrawal rule — a rate intended to make your money last for at least 30 years — you’d need at least a $2.5 million portfolio. Of course, your own annual cash-flow needs from your nest egg may be higher or lower than $100,000. And, you may need to employ a combination of strategies, depending on the particulars of your situation.
“The best way to end up with tax-free income is to pay the taxes first — and the best way to do that is to contribute to [a Roth account] throughout your working years,” said CFP George Gagliardi, founder of Coromandel Wealth Management in Lexington, Massachusetts.
Health savings account
If you have access to a health savings account — which can only be paired with a high-deductible health plan — it can be used as a way to generate some tax-free income in retirement. Unlike with the similarly named health flexible spending account, you don’t have to spend HSA money within a certain timeframe.
HSA contributions are tax-deductible, gains in the account grow tax-free, and withdrawals used to pay for qualified medical expenses are also tax-free and penalty-free. (At age 65, withdrawals can go toward anything without paying a penalty, although if the money is used for non-medical expenses, it would be subject to tax). You can contribute $3,600 to an HSA in 2021 ($7,200 for family coverage). If you’re age 55 or older, you can put in an extra $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 generally not subject to federal tax. If the bond is issued in your state of residence, it also may be tax-free at the state level, as well. However, “if you buy munis for a state you don’t live in, you’d have to pay state income tax for those,” said Ramnani at Francis Financial.
Any gain on an investment held for more than a year is considered long-term and is generally taxed as such. (Otherwise, it’s taxed as ordinary income.) The same goes for qualified dividends.
For long-term gains, the tax rate depends on your income. If you are a single tax filer with up to $40,000 in income ($80,000 for married couples filing jointly), the rate is 0%. If you can keep your income below those thresholds, those gains can be tax-free income. Keep in mind, though, that taxes are just one consideration when it comes to any investment strategies in retirement.
“You have to think about portfolio allocation,” Ramnani said. “Are you allocated in a way that is well-diversified and in line with your risk tolerance and goals? There can be competing objectives or considerations.”
While permanent life insurance policies generally come with much higher premiums than term life insurance, part of the reason for that is the savings aspect of these policies. “The idea is that you pay those high premiums and some of it goes to the insurance piece and the other part goes into a savings and investment bucket,” Ramnani said.
Depending on the specifics, these so-called cash value life insurance policies can be used to produce retirement income that is not subject to taxes, said CFP Michael Resnick, senior wealth management advisor for GCG Financial in Deerfield, Illinois.
Depending on how much you receive from Social Security and your other income, your benefits may be subject to tax. 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.
There are, of course, additional types of income that could come your way in retirement and not be subject to taxes. For instance, if you get divorced, alimony (spousal support) is not taxable to the recipient if the divorce occurred after 2018. Also, if you receive a gift from, say, a family member, it is not taxable to you.
The same goes for life insurance proceeds if you are the beneficiary of the policy. And, any gain on the sale of your primary home generally comes with an exclusion: Up to $250,000 is exempt if you are a single tax filer and $500,000 for married couples filing jointly.
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