Tax Free Income in Retirement

Tax-free income is the ability to withdraw from federally qualified accounts in retirement without those withdrawals triggering ordinary income tax. Because we don’t know how future tax policy will change, having tax free income give you the flexibility to deal with the ever changing tax policy of Federal, State and Local authorities and provides you with a place to secure money when unexpected expenditures pop up – without complicating your tax filing.

The IRS obviously prefers that all accounts be taxable at some point, so your options to receive tax free earnings are limited. Currently you have the option of investing in municipal bonds; whose dividends are federally tax free. Some municipalities offer bonds that are exempt from both state and federal taxes. This bond interest does show up on your tax forms, which does make it count against what portion of Social Security may be taxes. Second are distributions from Roth IRAs, which allows more flexibility to invest in a variety of investments. There are some limits to accessing the money tax-free so you have to have planned ahead to have any substantial source of tax free income from this method, and Roth IRA contributions are not allowed for those above certain MAGI income limits.

Municipal bonds can be volatile and carry interest rate, inflation, credit and default risks. Interest income generated by municipal bonds is generally expected to be free from federal income taxes and, if the bonds are held by an investor resident in the state of issuance, state and local income taxes. Such interest income may be subject to federal and/or state alternative minimum taxes. Investing in municipal bonds for the purpose of generating tax-exempt income may not be appropriate for investors in all tax brackets. Short and long-term capital gains and gains characterized as market discount recognized when bonds are sold or mature are generally taxable at both at the state and federal level. Short and long-term losses recognized when bods are sold or mature may generally offset capital gains and/or ordinary income at both the states and federal level. To qualify for the tax free penalty free withdrawal of earnings, a Roth IRA must be in place for at least fix tax years, and the distribution must take place after age 59 ½ or due to death, disability, or a first time home purchase (up to $10,000 lifetime maximum.) Before taking any specific action, be sure to consult with your tax professional.

A third, and often overlooked, way of developing tax free earnings is to utilize cash value life insurance. Many permanent life insurance policies accrue accessible cash value within the policy that can grow year-over-year by way of an index, dividends from the issuing company, or a stated interest rate. This growth can be accessed without the assessment of taxes if the distribution follows basic IRS rules for tax-free distributions from life insurance.

Trilogy Advisors are poised to help you understand examine your current retirement tax-free income strategies, and how they can be bolstered and improved by some or all of these effective methods.

Tags: Tax Management
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