Tax-Free Retirement Planning

A comprehensive retirement plan has multiple income streams. As many of these income streams as possible should be tax-free. There are several ways to generate tax-free income in retirement. However, this requires some dedicated planning.

Tax-free retirement planning is accomplished through an individualized road map that outlines which tax-free vehicles and strategies should be utilized to create the greatest amount of tax-free income possible. It is not uncommon to enter the 0% tax-bracket in retirement when proper planning is accomplished. In our firm, we call this road map a Retirement Income Maximization Strategy (RIMS) Report™.

Pre-tax retirement plans, such as 401(k)s and traditional IRAs, are generally the antithesis of tax-free retirement planning. While many refer to them as tax-deferred, they are increasingly being referred to as tax-procrastination plans. These plans allow you a token benefit of perceived upfront tax-savings by allowing you to contribute on a pre-tax basis and procrastinate taxes due on those contributions and any gains until later. 

What’s the problem with this? Being over $30 trillion in debt and having unfunded liabilities well north of $200 trillion, will the government be able to honor all its promises without raising revenue (taxes) throughout your retirement? Most economist and experts say no. Unfortunately, the myth of retiring to a lower tax-bracket has been adopted by mainstream media and hardworking Americans alike. The truth is that taxes will likely rise significantly throughout your retirement. All you have to ask yourself is, “Will the government need more or less money in the future?” With that in mind, pre-tax retirement vehicles heighten the tax-threat on your money by procrastinating the tax-day of reckoning until a time when taxes are likely higher and you have fewer deductions. We see this all too often when people come to visit with us. 

Adding insult to injury, these tax-procrastination plans often taint your social security benefits with unnecessary taxes. If your social security benefits are taxable, it’s not the fault of your benefits. Social security benefits are almost never taxable on their own. However, 401(k)s and IRAs almost always trigger taxes on your social security, and up to 85% at your highest marginal tax rate. That’s just an additional tax burden brought to your doorstep by a pre-tax retirement plan.

For a deeper dive into taxes and pre-tax retirement plans, please visit our blog posts The Tax Columns–How Will Taxes Affect My Retirement? and How Much Does My 401K Save Me In Taxes? 

If you are like most people that have diligently saved for retirement, you may have accumulated a decent amount of savings in pre-tax retirement plans like 401(k)s and IRAs. While these vehicles subject you significan taxation and are generally poor distribution (income) vehicles, there is hope. 

A RIMS Report™ can show you a path toward a more tax-efficient retirement, potentially even achieving the 0% tax-bracket in retirement. 

• What assets should be converted or shifted to tax-free vehicles or strategies?
• What tax-free strategies are right for you?
• Over what time period should this be accomplished in your situation?
• How can you get your social security benefits tax-free?
• How can you get portions of your 401K or IRA tax-free?

Typically, a RIMS Report™ demonstrates a healthy increase in both net-spendable retirement income and the longevity of retirement assets through intelligent, purposeful tax-free planning. Unfortunately, most experts agree that tax increases are inevitable. These are particularly harmful to retirees. The more tax-free streams of income you can create, the more insulated you are against these inevitable tax increases.

There are some landmines out there in creating a tax-free road map. Working with a professional that specializes in tax-free retirement planning is key. 

Key Considerations
Tax diversification is key. Even though taxes are poised to rise sharply, there will inevitably be years in which taxes are lower than others for you. Leaning more heavily on taxable and tax-deferred accounts in those years might make sense, letting your tax-free retirement vehicles grow untouched during those periods. However, when taxes are more burdensome, having those tax-free accounts to lean on will likely prove to be a major boon.

There are also geographic considerations. For instance, 34 states do not tax military retirement income. Some states do not tax distributions from pensions or defined contribution plans like 401(k)s. Many retirees relocate to such places to enjoy a state income tax-free income.

Other factors, such as age, health, desired lifestyle, and savings ability should be considered when creating a tax-free road map.

A Roth IRA account is an account that is funded with after-tax money but offers tax-free growth. While there are income limits that might “phase out” your ability to contribute to a Roth IRA, anyone can convert an IRA to a Roth IRA. These income phase outs do not apply to a Roth 401(k), however. 

Roth IRAs do not have Required Minimum Distributions (RMDs) (like 401(k)s and Traditional IRAs), but strangely Roth 401(k)s do have RMDS even though it triggers no tax. This is easily avoided by transferring your Roth 401(k) to a Roth IRA. Finally, Roth IRA distributions do not trigger taxes on your social security benefits because the distributions do not count as “provisional income”. 

In 1997, the Roth IRA was signed into law after being modeled after similar tax provisions that govern the Life Insurance Retirement Plans (LIRP) discussed below. 

A few small consideration for a Roth IRA:

• You must be 59 ½ years old and have had a Roth for 5+ years to use the gains tax-free. Withdrawals prior to 59 ½ (or prior to having a Roth for 5 years) will usually cause taxes and penalties on your gains.
• Your contributions however are free of tax or penalty to you at any time. 
• Contribution limits are small: $6,000 per year for those under age 50; $7,000 per year for those 50+. However, you and your spouse may each have one.
• No limit on Roth conversions from 401(k)s/IRAs
• Earned income is required in order to contribute. 

A LIRP is a type of cash value life insurance that has been stripped down and optimized to function as a retirement tool, shedding many of the expenses that plague traditional permanent life insurance options (that do not qualify as a LIRP). 

A properly structured Life Insurance Retirement Plan allows for after-tax contributions and tax-free growth and distributions. There have some significant advantages:

• No contribution limits
• No age 59 ½ restrictions
• Highly liquidity
• Tax-free growth and distributions
• Term insurance death benefit that doubles as long-term care if needed
• Locking in of annual gains
• Protection against market losses
• Distributions do not trigger taxes on social security benefits
• Specifically engineered for income production

The drawback to a LIRP is that you must be decently healthy. Many normal health challenges that come with aging are acceptable, but if someone has had significant health challenges, a LIRP may not be the right answer.

For a more in depth review of this potentially powerful tool (and its misuses), please visit or blog post Tax-free Retirement–Utilizing a LIRP As Part of a Tax-free Retirement.

 A Roth IRA and a LIRP can make a powerful combination of tax-free streams of income. 

A third stream of tax-free income can be your social security benefits. Whether or not your social security comes to you tax-free or up to 85% taxable at your highest marginal tax bracket depends entirely on the other elements of your retirement strategy. Assuming proper planning has been accomplished in those other areas, your social security benefits can come to you tax-free. 

Learn more about the negative effects of provisional income on your social security on our blog. 

There is an ideal balance to have in your pre-tax accounts such as 401(k)s and IRAs. By arranging your affairs properly in the other areas of your retirement strategy (mentioned above), and through the wise use of the standard deduction, you can have your pre-tax accounts generate a fourth stream of tax-free income. So long as you have shifted or converted enough of your pre-tax assets to tax-free strategies such that the RMD of your pre-tax accounts will not exceed the standard deduction, you can enjoy this income stream tax-free as well. Consideration regarding provisional income thresholds should also be had in determining how much of your pre-tax assets to convert or shift. 

Developing the appropriate tax-free retirement strategy can be demanding. Do not navigate this complex process alone - work with a professional that can review your tax-free retirement options with you. Call us at (877) 317 5999 or schedule a free visit for more on tax-free retirement planning.