One of the essential goals of any retirement strategy is to ensure your future financial stability when you’re no longer working. A key way to do this is to reduce your expenses in retirement as much as possible.
Taxes are one of the biggest expenses retirees often face. As a retiree, you’ll likely be required to pay taxes on Social Security, pension benefits, retirement account distributions and more. This significant tax bill often takes many people by surprise, and it can critically affect your retirement savings.
By planning ahead, however, you can help minimize your tax exposure and take steps to help protect your retirement security. A variety of tools are available to help you generate tax-free retirement income. Below are four strategies to consider adopting today as part of your overall retirement plan to help reduce your future tax burden:
A traditional IRA is a popular retirement savings vehicle because it offers tax-deferred growth and the ability to make tax-deductible contributions. However, all distributions from this type of account are taxable. That can be problematic for many retirees.
With a Roth IRA, upfront contributions are not tax-deductible, but you still benefit from tax-deferred growth on the funds inside the account. The major advantage of a Roth IRA, however, is that it enables you to make tax-free withdrawals in retirement after you reach age 59½.
Consider using a Roth IRA to save for retirement, as it could create a source of tax-free income in the future. If you have a traditional IRA but would prefer to have a Roth, you have the option of doing a Roth conversion. This is the process in which you convert traditional IRA funds into a Roth. You have to pay taxes on the converted amount, but that could be worth it if it reduces your tax liability in retirement.
Cash Value Life Insurance
Also sometimes called “permanent insurance,” cash value life insurance includes a number of different insurance types, such as whole life, universal and variable. Each has its own set of features and benefits, but the main advantage they all share is that your cash value grows tax-deferred.
Permanent insurance enables you to withdraw your premiums tax-free and then take the growth out as tax-free loans. You could use your permanent life insurance policy as a source of supplemental tax-free income after you retire. Just be aware that if any loans aren’t repaid, they’ll be deducted from the death benefit after you pass away.
A variety of local governmental and nonprofit entities, such as hospitals or public works departments, issue municipal bonds to raise capital. The interest on these bonds is paid tax-free to the bondholder. You can buy them as individual bonds, or you can buy mutual funds that specialize in municipal bonds.
One important note to remember is that if you sell a bond for a gain, that gain could be taxable. Otherwise, municipal bond interest can be a source of tax-free income in retirement.
Health Savings Account (HSA)
This is technically not a source of tax-free income that can be used for general purposes. However, an HSA can be used to generate tax-free income to cover medical expenses. It exists specifically for this purpose and can be very beneficial when it comes to covering your health care costs in retirement.
With an HSA you can make tax-deductible contributions, which then grow tax-deferred as long as they stay in the account. You are then eligible to take tax-free withdrawals to pay for qualified medical costs.
Considering the cost of health care these days, you may want to think about contributing to an HSA as an essential part of your retirement savings strategy. A financial professional can help you take the next steps if any of these options sound right for you.
Ready to plan your tax-free retirement? Let’s talk about it. Contact us at Gregory Financial Group. We can help you analyze your needs and develop a strategy. Let’s connect soon.
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