Most retirees must plan to live on a more limited budget than they enjoyed during their working years. To some degree that can be very doable, especially if you carefully pay down debts and no longer incur commuting expenses. But if you receive a surprising income tax bill, your budget can be seriously disrupted. That’s why preparing for income taxes in retirement is so important.
One way to ward off this possibility is to educate yourself on how income taxes impact retirees, and to anticipate your tax debt each year. But another, possibly more obvious, strategy is to simply establish retirement income that is not subject to income taxes.
Generally speaking, you have five options for setting up non-taxable income in retirement:
Roth accounts. During your working years, the money that you contribute to a Roth 401k or IRA has already been taxed as regular income. So when you make withdrawals in retirement later, the government does not tax that income again.
Municipal bonds. City and state governments sell municipal bonds to the public, as a way to fund projects like roads and schools. Later you will earn interest on the money you invested into your community. This income is considered non-taxable by the federal government, and some states don’t tax it, either.
Health savings account withdrawals. If you’re currently enrolled in a high-deductible healthcare plan, you can save money in a health savings account to help pay for medical expenses. Withdrawals are not taxed when used for qualified healthcare expenses.
But when that money isn’t used, it rolls over from year to year. If you continue to save money in the account throughout your working years, you can use that money (tax free) to pay for the cost of your healthcare in retirement. It’s not exactly “income”, but it’s close.
Life insurance payout. Since the benefits from a life insurance policy are paid on a non-taxable basis, a life insurance policy is a great way to leave non-taxable income to your spouse.
Social Security benefits. Social Security benefits won’t be taxed, as long as your total annual taxable income does not exceed a certain threshold. Combine Social Security payments with other forms of non-taxable income, and you can potentially stay below those limits and avoid income taxes altogether.
Call us to schedule an appointment, and let’s review your retirement plan. If avoiding surprise income tax bills is important to you, we can help you devise a strategy for non-taxable income in retirement.
