Taxes are one of the biggest factors in retirement. Here are a few strategies to minimize your tax bill, and earn tax-free income during retirement.
Here are a few strategies you can put into place to minimize your tax bill, and earn tax-free income during your retirement.
When planning for your retirement, there are many options on your plate to consider. From the cost of healthcare, to maintaining the health of your portfolio. One of the biggest factors to consider is your tax strategy. Any amount you owe to the IRS will come out of your retirement savings or income. Check out these account options for earning tax-free income during your retirement.
Having a Roth version of an individual retirement account (IRA) or 401(k) can help set yourself up for success. Roth accounts allow you to pay taxes on money going into the account, and all future withdrawals after age 59 ½ are tax-free.
Here are contribution limits for Roth IRA and Roth 401(k) accounts:
- The maximum contributions you can add to a Roth IRA is $6,000 ($7,000 if ages 50 and older).
- Single taxpayers: that amount begins to phase out at income of $125,000; and disappears at income of $140,000.
- Married couple filing jointly: $198,000; and disappears at income of $208,000.
- There is no income cap. You have the ability to contribute up to $19,500 in 2021; and an additional $6,500 if you’re age 50 or older.
To work around the Roth IRA income cap, consider contributing to a traditional IRA and convert the money to a Roth account. You may owe taxes when converting accounts, but you’ll avoid paying taxes on distributions in the future.
Health Savings Account
A Health Savings Account (HSA) can help lower your overall cost of healthcare. This type of savings account allows you to set pre-tax money aside to help cover the cost of eligible medical expenses. Funds in the HSA rollover year to year if you don’t spend them, and your HSA may earn interest which is not taxable. These eligible expenses can range from deductibles, copayments, coinsurance, and medical supplies. You can use these funds at any time, but can only contribute if you have a High-Deductible Health Plan (HDHP). A HDHP generally only covers preventive services before the deductible.
- For 2021, the minimum deductible is $1,400 for individual and $2,800 for a family.
- For the plan year 2022, the minimum deductible for HDHP is $1,400 for individuals and $2,800 for families.
- For 2021, if you have a HDHP, you can contribute $3,600 for self-only coverage and up to $7,200 for family coverage.
- For 2022, if you have a HDHP, you can contribute up to $3,650 for self-only coverage and up to $7,300 for family coverage.
Municipal “Munis” bonds are issued by states, counties, and cities to fund public projects, like construction of highways, bridges or schools. The interest you earn on these types of investments are generally not subject to federal tax. In addition, if you have a bond issued in your state of residence, it might be tax-free at the state level. Keep in mind, certain munis are subject to federal tax, so be sure to research details or consult your tax advisor before investing.
Here are the different types of municipal bonds:
General obligation bond (GO)– is issued by government entities and not backed by a specific project, like a toll road. Some GO bonds are backed by dedicated property taxes or general funds.
Revenue bond– are not backed by a government’s taxing power, but instead are backed by revenues from a specific project, like a toll road.
To learn more about Municipal Bonds and the opportunity to invest, visit the U.S. Securities and Exchange Commission website.
Life Insurance and Annuities
Cash value life insurance is a type of permanent life insurance which includes the ability to invest. The cash value portion of your policy can earn interest, and may allow you to withdraw or borrow against funds. Options can vary, but you can use cash value life insurance policies to generate retirement income not subject to tax . However, it’s important to consider distributions and verifying any taxes associated. The types of permanent life insurance which include cash value are:
- Whole life insurance
- Universal life insurance
- Variable universal life insurance
- Indexed universal life insurance
Depending on your plan and coverage options, life insurance policies typically offer two features:
Death benefit– is the amount paid to beneficiaries in the event the insured primary person passes away. Sometimes this is referred to as the “face value” of your policy.
Cash value– is the additional feature that can make your policy more valuable, and allow you access to funds while you’re living. Depending on your policy, if your withdrawal amount is more than the amount you paid into the cash value, it can be taxed as income. In addition, withdrawing your cash value reduces the death benefit paid to your beneficiaries.
Annuities can provide a source of income in retirement. An annuity is insurance for your retirement income, and allows you to convert a portion of your assets you already have into steady income. By using after-tax money to fund your annuity account, generally, only the interest is taxable. Some types of annuities protect your income from loss, or help you save by offering a fixed rate of return for a set period of time.
The two main types of annuities include:
- Immediate Income Annuities (SPIAs) – are intended for those retired or nearing retirement, and are wanting guaranteed income to start within a year.
- Deferred Income annuities (DIAs) – are for those who are still saving for retirement and need guaranteed income payments for the future.
There are many different types of annuities, and they can sometimes be more expensive than other options for income. Be sure to consult your financial advisor to see what works best for you.
Depending on your income amount and how much you receive from Social Security, your benefits may be subject to tax. You can calculate by adding one-half of your benefits to your Adjusted Gross Income (AGI), and nontaxable interest. If your total amount is between $25,000 and $34,000 for single filers, $32,000 to $44,000 for married couples filing jointly, then half the amount is taxable. If the amount is below either income range, it’s not taxed; if the amount is above the range, then 85% is taxable. In addition, if your deduction(s) can lower your taxes if you have taxable income.
Outside of these income sources, you may receive income during retirement not subject to taxes. Here are a few examples of non-taxable income in retirement.
- Alimony – in the event of a divorce, spousal support isn’t taxable if the divorce occurs after 2018.
- Gift from family member
- Life insurance proceeds – if you are the beneficiary on the policy.
- Sale of a home – income you earn from selling your primary home is usually not taxable, if within the exclusion: up to $250,000 is exempt for single filers, and $500,000 for married couples filing jointly.
It can be difficult trying to make sure you have enough funds in retirement, and managing the health of your portfolio. There are many different options, each can work a different way to benefit you. We’re here to help you go through your options, and make the most of your money. Contact us if there’s anything we can do to help.
This material contains only general descriptions and is not a solicitation to sell any insurance product or security, nor is it intended as any financial or tax advice. This may not take into account your personal characteristics such as budget, assets, risk tolerance, family situation or activities which may affect the type of insurance that would be right for you. Guarantees are based on the claims paying ability of the issuing company.
Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals more prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local tax may apply. If sold prior to maturity, capital gains tax could apply.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.
Traditional IRA account owners have considerations to make before performing a Roth IRA conversion. These primarily include income tax consequences on the converted amount in the year of conversion, withdrawal limitations from a Roth IRA, and income limitations for future to a Roth IRA. In addition, if you are required to take required minimum distribution (RMD) in the year you convert, you must do so before converting to a Roth IRA.
While the tax or legal information provided is based on our understanding of current laws, and has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information is not intended to be a substitute for specific individualized tax or legal advice and should only be relied upon with individual professional advice. Neither LPL Financial, nor its registered representatives, provide tax or legal advice. AS with all matters of tax or legal nature, you should consult with your own tax or legal counsel for advice.
The information provided in these articles is intended for informational purposes only. It is not to be construed as the opinion of Central Bancompany, Inc., and/or its subsidiaries and does not imply endorsement or support of any of the mentioned information, products, services, or providers. All information presented is without any representation, guaranty, or warranty regarding the accuracy, relevance, or completeness of the information.