November 16, 2022

Generating tax-free income during retirement may seem like a challenge. However, there are several strategies you can implement to achieve your tax-free retirement dream. While most people will pay taxes on their Social Security benefits, 401(k) distributions, pension income, and a variety of other retirement income sources, implementing strong tax-saving strategies now can significantly reduce the amount you’ll have to pay in taxes during retirement.

For this reason, starting early is key, as waiting too long to begin saving can have serious effects on the effectiveness of the most common tax-saving strategies. Below, we’ll outline several strategies for starting your tax-free retirement journey today. Of course, the best way to ensure you are headed towards a truly tax-free retirement is to work alongside an experienced tax strategist.

Roth Contributions

Funding a Roth IRA is a simple way to generate tax-free income during your retirement. However, because Roth accounts carry both income and contribution limits, it’s important that you begin saving as early as possible to ensure your income doesn’t price you out of this tax-free retirement account.

You can generally make a maximum annual contribution of $6,000 ($7,000 if you’re 50 or older) to your Roth IRA each year. However, once you reach a certain income threshold — $125,000 for a single taxpayer or $198,000 for married couples filing jointly — your annual contribution maximum begins to lower. At an annual income of $140,000 for single taxpayers and $208,000 for married couples, you can no longer make contributions to a Roth IRA.

In comparison, Roth 401(k) accounts have no upper salary limit. Further, in 2022 the IRS increased the contribution limit to a maximum of $20,500 per year (plus an additional $6,500 if you’re over 50). This means that anyone can contribute an amount up to this limit.

As you might imagine, each account has different pros and cons depending on your specific situation, so it’s wise to work with an experienced tax strategist to determine which account may be best for your financial situation. For example, if your income exceeds the limit for a Roth IRA, you may want to consider a Roth IRA conversion or other alternative investment strategy. Even if you have a non-deductible IRA, you can utilize a Roth rollover (or conversion).

Roth IRA Conversions

Because your tax bracket and overall tax burden will generally rise as you get closer to retirement, it may be advantageous to consider a Roth conversion as a means of paying less taxes on your withdrawals.

A Roth conversion occurs when you transfer funds from a non-Roth account (such as a traditional IRA or a normal 401(k) account) into a Roth account. While you will have to pay taxes on the funds at the time of conversion, the benefit of this strategy is that you may be able to pay less overall taxes by choosing to convert when you are in an advantageous tax bracket (as opposed to later in life when you may be in a bracket with higher tax rates).

For this reason, a Roth IRA conversion is a great choice even for high earners due to the significant tax savings you can generate over the life of the fund. You will have to pay taxes to get money into the Roth IRA. However, by paying taxes before the investment period has reached its maximum financial potential, you may be able to pay less in the long run and enjoy additional tax-free withdrawals when it’s time to retire.

Permanent Life Insurance

For the purposes of retirement and tax planning, you should consider a permanent life insurance policy as an additional asset class. In short, you can set up a life insurance account similarly to a Roth IRA. However, this type of account comes without any restrictions on income or contributions.

Your premium payments won’t qualify for a tax deduction, but the money will grow tax-free. If handled correctly and strategically planned, this method can result in tax-free income during retirement.

Although the premiums for permanent life insurance are often substantially higher than those for term life insurance, the savings-oriented nature of these policies make it a good option for a tax-free retirement. Depending on the terms, these cash value life insurance plans can be utilized to generate additional tax-free retirement income.

Health Savings Account (HSA)

Contributions, growth, and, if used properly, withdrawals from an HSA are all tax-deductible expenses. Though the purpose of an HSA is to pay for medical expenses, there is no set time frame during which you must use the money stored in an HSA account.

This means that the HSA’s assets can continue to grow and compound until you reach retirement. After that, you can pay yourself back for all your previous medical bills, assuming you kept your receipts.

To open an HSA, you need to have the right kind of health insurance coverage. You also must consider contribution limits, which, as of 2022, are $3,650 for single-filers and $7,300 for families. However, despite the relatively low contribution limits, an HSA account can be a powerful, tax-free income stream you can draw from during retirement.