4 Potential Sources of Tax-Free Income in Retirement

Financial stability is an important part of a happy and fulfilling retirement. Financial stability allows you to spend your golden years doing the things you’ve always wanted to do. Part of creating financial stability in your post-work years involves managing your expenses and living within your means.

There are many ways to accomplish this. You could look at ways to trim your budget by limiting spending on things like dining out, vacations or costly hobbies. You could downsize to a smaller and less expensive home. Or you could take steps to minimize one of the largest costs you may face in retirement - taxes.

Taxes don’t stop just because you stop working. Income sources like Social Security, pension benefits and retirement account distributions could all be taxable. Fortunately, there are steps you can take to limit your tax liability. Below are four things you can do to increase your tax-free income in retirement:

Roth IRA

A Roth IRA is a popular retirement savings that can generate tax-free income in retirement. While a Roth IRA shares some similarities with traditional IRAs, there are also major differences between the two. With a traditional IRA, you’re able to make tax-deductible contributions, and the growth in the account is tax-deferred. The trade-off, however, is that when you go to withdraw those funds from your account, you are required to pay taxes on the distribution.

With a Roth IRA, on the other hand, you can’t deduct upfront contributions. There is still tax-deferred growth inside the account. However, since your contributions are after-tax, your distributions from the IRA in retirement are tax-free. As long as you’re age 59½ or older and the Roth has been open at least five years, you can take tax-free income from the account.

A Roth is a helpful tool that can help reduce your retirement tax burden. You simply need to open one and start making contributions. Even if you already have a traditional IRA, you can potentially convert it to a Roth. The Roth conversion process allows you to transfer traditional IRA funds into a Roth. You have to pay taxes on the converted amount, but it could be worth it to create a tax-free income stream.

Cash Value Life Insurance

Many people don’t think about life insurance when they think about retirement income. However, cash value life insurance is a potential tax-free income source. Another name for cash value insurance is permanent insurance. There are several different types of insurance that fall into this category. For instance, things like whole life, universal and variable are all types of insurance that would be considered cash value or permanent insurance.

There are a few benefits that come with permanent insurance, one being that your cash value grows tax-deferred inside the policy. When you need income, you can withdraw your premiums tax-free. Then, after you’ve withdrawn all your premium payments, you are allowed to take loan distributions. These loans are also tax-free, since they must be repaid. If you fail to repay the loans during your lifetime, the balance is simply deducted from the death benefit.

Municipal Bonds

Municipal bond income could be another way to manage your tax liability in retirement. These bonds are issued by state governments, municipalities and even some nonprofit organizations, such as hospitals or public works departments. The interest payments on these bonds are usually tax-free. It’s possible for you to simply buy individual bonds, or you could buy a mutual fund that specializes in municipal bonds. It’s important to note, though, that if you sell a bond for a gain, that gain could be taxable.

Health Savings Account (HSA)

​Even though you have to use the funds in your HSA for qualified medical expenses, it is still a valuable tool that can provide tax-free cash flow in retirement. It also gives you an income source that can help cover the high cost of medical care. The contributions you make to your HSA are deductible and grow tax-deferred while they are in your account. You can then take a tax-free withdrawal when you need to pay for certain medical costs. That could be a valuable resource as out-of-pocket medical costs in retirement can be substantial. 

Ready to plan your tax-free retirement? Let’s talk about it. Contact us at Baacke Insurance Services. 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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