Life can get busy quickly (the understatement of the year). Between kids, work, pets, and friends, we often have little downtime. With the lure of having more time to travel, pick up a new hobby, or visit with family and friends, it’s no surprise that many people in the modern workforce eagerly await the day they can finally retire.
What many don’t consider, though, is how to actually get there. The golden rule of retirement? The earlier you start planning, the easier it will be to achieve. So, as you’re preparing to trade in your 9 to 5 for the long-awaited golden years, company meetings for family time, and the morning commute for the snooze button, you need to consider one more thing — your paycheck.
While it’s safe to say that no one enjoys handing over their hard-earned dollars to the IRS, the thought of doing so on a fixed income is especially daunting. Yet, with careful planning and preparation, it doesn’t have to be.
To help you put a better financial strategy in place, our Mount Pleasant financial advisors at Morris Financial Concepts have compiled a list of tax-free income streams to diversify your retirement portfolio and allow you to enjoy your golden years with minimal stress.
How to Minimize Your Post-Retirement Tax Burden
The first step in retirement planning is understanding what your sources of income will be, then figuring out how to make them comfortably last. While taxes are a certainty in life, planning ahead can help you strategize which sources of income will minimize your tax burden in the long run. Here are a few ways that you can minimize your financial load:
Contribute to a Roth IRA
One of the most well-known forms of tax-free income post-retirement is a Roth account. Where a traditional retirement or Roth 401(k) account taxes your withdrawals, a Roth individual retirement account (IRA) taxes your contributions instead. This allows retirees who are now in a higher tax bracket to pay taxes before their rate increases. Even those who retire into the same or a lower tax bracket could benefit from a Roth IRA, as traditional and 401(k) account distributions may push you into a higher income bracket and increase your overall tax burden.
For those keen on early retirement, that money is available whenever you need it, and it will continue to accrue interest until then. Keep in mind that not everyone is eligible to make Roth IRA contributions. Your income may be above the threshold, in which case, there are other ways to build assets in a Roth IRA, such as the Backdoor Roth IRA and Mega Backdoor Roth IRA. These methods essentially allow you to get around the income cap by, for example, contributing to a traditional IRA and then converting that money to a Roth IRA.
The maximum you can contribute in a year to a Roth IRA is $6,000, or $7,000 if you’re over the age of 50. That amount starts phasing out at $125,000 for a single taxpayer and $198,000 for married couples filing a joint tax return. Contributions disappear entirely at incomes of $140,000 for singles and $208,000 for couples. Roth 401(k) accounts are much more generous, with no income cap, and contributions up to $19,500 in 2021 (plus an additional $6,500 for those over the age of 50).
If you’re interested in contributing to your Roth IRA, tax planning in Mount Pleasant at Morris Financial Concepts can help. While this method is fairly straightforward, it’s certainly not the only way to increase your tax-free retirement income. Building up your retirement nest egg may involve any number and/or combination of financial strategies.
Grow Your Health Savings Account (HSA)
Another way (and an underutilized one at that) to build up your nest egg is with a Health Savings Account. Not to be confused with a health flexible spending account, an HSA allows you to set aside tax-free money for qualifying healthcare expenses. This includes anything from over-the-counter treatments such as eye drops or aspirin to larger medical expenses such as hospital services, long-term care payments, prescriptions, and vision and dental care.
People over the age of 65 can even spend the money on non-medical expenses without a penalty fee (though it would be subject to tax). HSA contributions, withdrawals, and gains are all tax-deductible, meaning they are primarily designed to give tax breaks to people with high-deductible health insurance plans. Nonetheless, they can also make for strong retirement planning assets. The caveat to this method is having access to one, as an HSA can only be paired with a high-deductible health plan.
Plus, the balance of an HSA carries over each year, and most providers offer investment options to help you grow your savings. With no required minimum distribution, you can leave the account untouched and let the growth accumulate. Currently, you are able to contribute $3,600 or $7,200 for family coverage to an HSA. For those over the age of 55, you can allocate an additional $1,000.
Invest in Cash Value Life Insurance
We’re talking about retirement planning, not legacy planning, so how does life insurance play into the mix? If you’re familiar with life insurance or have a policy of your own, you may know that permanent life insurance policies have higher premiums than term life insurance. This is because part of that premium goes toward an accumulation of money called the cash value.
While death benefits still pass to your beneficiaries, the cash value provides a financial benefit for you to use in life. Depending on the policy you choose, the tax-deductible cash value can grow through steady interest, similar to a savings account (often with better interest rates), or it can be re-invested for potentially higher gains. Your cash value is not subject to capital gains taxes, and withdrawals are tax-free up to the amount you contributed in premiums. You can even take out a tax-free loan against your cash value as long as your policy is in effect.
Cash-value life insurance policies do have their drawbacks. The cash value does not pass on to your beneficiaries unless you buy a supplemental endorsement, and additional withdrawals and loans may reduce the death benefit. Additionally, a wealth of other complexities may be involved in distribution.
Capitalize on Long-Term Capital Gains
With capital gains taxes in the news, this may seem like an odd choice for our list. Nonetheless, the tax brackets for long-term capital gains have much more leeway than typical income tax brackets, and you may be surprised to find out you qualify for a 0% rate.
Long-term capital gains refer to the income you make when you sell property that increased in value while you held it, given that you owned it for more than a year. It uses your taxable income, not your gross income, to determine your tax bracket, and instead of the seven federal income tax brackets, it only has three: 0%, 15%, and 20%. To qualify for a 0% tax rate in 2021, taxable income must be under $80,800 for families and $40,400 for individuals. With standard deductions, personal exemptions, and tax-advantaged accounts taken into account, many retirees fall within this bracket.
Even if your usual taxable income is higher, you may be able to create a low-tax year by delaying Social Security benefits and focusing withdrawals to your Roth accounts for the year. Selling long-term assets during a low-tax year allows you to keep the profits tax-free, and you can start your Social Security benefits and return to other accounts the following year. Before you start selling, take note: long-term capital gains only qualify for the 0% rate until the gain added to your taxable income reaches the upper limit of the 0% taxable income bracket, and further gains are subject to the 15% tax.
Because this strategy may only be beneficial to certain individuals, it’s important to talk to your financial advisor about your investment portfolio’s risk, diversification, and long-term objectives.
Invest in Your Future with a Financial Advisor
There is no one-size-fits-all when it comes to retirement planning. Since there are many paths that can lead toward a secure retirement, planning can be tricky to navigate. To speak with an expert who can help maximize your retirement income while minimizing your taxes, reach out to one of Morris Financial Concepts Mount Pleasant financial advisors today.
The opinions expressed herein are those of Morris Financial Concepts, Inc. (“MFC”) and are subject to change without notice. MFC relies on information from various sources believed to be reliable, including third parties, but cannot guarantee the accuracy and completeness of any third-party information. The information contained herein is for educational purposes only and is not intended to provide, and should not be relied upon for, accounting, legal or tax advice or investment recommendations. The recipient should take their own independent legal, tax and financial advice. MFC is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about MFC including our investment strategies, fees, and objectives can be found in our ADV Part 2, which is available upon request. MFC-21-11.