Will you be able to live on savings alone when you retire?
The average American retires at 62, and they need to stretch out their life savings for at least two decades. Meanwhile, there’s a growing trend of an increase in living costs (including skyrocketing healthcare costs).
Many wonder whether they’ll be able to achieve the quality of life they dream of on their savings alone.
If you are one of those who intend to invest during retirement, know that there are options for a tax-free retirement income.
How can you live a tax-free retirement? Check out these strategies for reducing your taxable income and keeping more of your money.
Pay Taxes Now to Save for Later
Many individuals rely on traditional retirement plans as a primary method of saving for retirement. All of these plans have tax implications, but Roth IRAs allow you to pay tax now to make the most of your money when you stop working.
1. Roth IRA
The Roth IRA is an account that allows you to accumulate assets in an IRA, receive tax-free growth, and tax-free withdrawals.
Roth IRAs are incredibly common. You can contribute $5,500 each year ($6,500 after 50 years of age) using after-tax dollars instead of tax-deductible contributions to a Traditional IRA.
If you are new to investing and saving, these are great starter accounts. However, the income and savings limits mean you’ll need to use other investment strategies to save for retirement.
2. Roth 401(k)
A Roth 401(k) allows you to grow and withdraw from your account without any tax implications.
Like the Roth IRA, contributions are made using after-tax dollars. However, you can contribute up to $18,500 until you are 50 when the number jumps to $24,500 (including a $6,000 catch-up allowance).
Tax-Free Investment Opportunities
Are you looking for places to send your money that don’t require any tax whatsoever?
3. Municipal Bonds
Buying municipal bonds or investing in municipal funds allows you to save money and earn income without taxation.
The IRS doesn’t count income from these as a source of taxable income (though you do have to report it). However, you may be required to pay state taxes depending on your state of residency. Additionally, if you earn capital gains, then you must pay taxes on that figure.
Keep in mind that like all other investments, bonds come with risks. If the municipality defaults on its obligations (usually through bankruptcy) you can lose your investment.
4. Buy a Master Limited Partnership
A master limited partnership (MLP) is a publicly traded partnership that provides a low-risk, low-tax, long-term investment.
Think of it as a hybrid organization: it’s a partnership and a corporation for tax benefits and liquidity.
Investors in MLPs receive tax-sheltered distributions, so you’ll generate a slow income stream over the long-term with limited tax liability.
5. Gifting Stock
Giving your money away is a simple way to earn an income and avoid tax. But doesn’t gifting your stock away mean you lose your asset? Not necessarily.
Let’s say you buy $10,000 in stock and earn $10,000. If you hold onto both, you’ll pay capital gains tax. Hold onto it long enough and hope for a lower tax over the long-term.
Alternatively, you can give the stock to a beneficiary. Sign it over less than a year after you buy it, and you’ll get to deduct the $10,000 you initially spent. If you allow it to sit for a year, you can deduct both the initial investment and the gains.
Tax-Free Savings Accounts
You know that a traditional savings account isn’t part of your journey towards sustainable retirement income. But health savings accounts are.
6. Health Savings Accounts
A health savings account (HSA) is an incredible opportunity that everyone in the process of retirement planning should consider.
HSAs hold funds used to pay for medical expenses only. However, you don’t need to use it now. You can continue contributing money now, and then reimburse yourself for expenses (including Medicare premiums) during retirement.
Here’s how great these accounts are for your tax bill:
- Contributions are tax-deductible
- Growth is tax-free
- Withdrawals are tax-free
You can only contribute $3,450 per person per year ($4,450 for those over 55).
7. Restricted Property Trust (RPT)
A Restricted Property Trust (RPT) is a strategy that allows business owners to grow assets while reducing your income taxes. Rather than an individual account, these are business-focused and employer-sponsored. The ideal candidates for these accounts include:
- C-Corps, S-Corps, LLCs
- Private Companies
- Physician Groups
The contribution minimums reflect this: it requires a minimum investment of $50,000 per year for a minimum of 5-years.
To set it up, a corporation creates two irrevocable trusts: the RPT and a Death Benefit Trust.
You then contribute to the Death Benefit Trust and make your minimum contributions to the RPT. The trust then uses the annual contribution to buy a cash value life insurance policy.
All RPT contributions are tax deductible and the growth of the cash value is tax-deferred. When the policy is distributed from the plan a tax is paid from the policy cash value.
Enjoy a Tax-Free Retirement
For many individuals, their greatest worry about retirement isn’t how to fill their newfound spare time, but if they will outlive their savings.
Taxes on retirement income take a chunk out of your savings and income after you already spent decades of your life paying in.
These seven options are just some of the tools available to those looking for a tax-free retirement income.
Are you a business owner with a qualifying corporation? You can use the RPT to minimize your tax obligations in retirement. Schedule a consultation to learn more.