Tax free Retirement Planning Strategies

Manage your tax bracket

(with tax minimization strategies)

What's your biggest expense in retirement?...It might be Taxes...

Planning for Tax Changes, Diversifying your tax rate exposure

Most people understand the importance of investment diversification and asset allocation to help mitigate and spread risk among your investment portfolio, but what about tax rate diversification? In retirement, having the ability to diversify among financial products that offer distributions from taxable, tax-deferred and especially tax free accounts becomes very important in the management of your tax bracket.

How does tax free retirement income help to manage your tax bracket? 
During retirement, each year you will take distributions from various sources such as qualified retirement savings plans like IRA’s, 401k’s, pension funds, and social security, all of which contain a future tax liability. They're all taxed as ordinary income upon distribution. Furthermore, you will be forced to take a distribution of these accounts upon turning 701/2 as dictated by the required minimum distribution rules, in other words, the IRS wants there money that has been growing tax deferred in those retirement accounts for many years.

If you're in a high tax bracket or are concerned about rising tax rates, pulling a portion of your funds from a tax free account in retirement will keep your total taxable income lower thereby potentially keeping you in a lower tax bracket. Thus, not only do you have the benefit of a tax free income source but also derive potential tax savings in the benefit of a lower tax bracket resulting in lower overall tax liability. You would use the taxable qualified retirement funds first to fill up the lower tax rate brackets and as you approach the higher tax brackets, minimize taxes with available tax exempt sources of income from life insurance cash values, Roth IRA's and municipal bond interest. With the potential for increasing tax rates moving forward due the the economic environment, tax free income sources are becoming more important than ever.

By diversifying via taxes, you can make the choice and take income from taxable or non-taxable sources as desired to optimize taxes.

The 3 tax buckets; taxable, tax-deferred and tax free

Most people will agree that that are paying more than their fair share of taxes. You can’t evade taxes, but you can work to avoid taxes. There are investment planning options available that offer various tax treatments. The tax treatments available to us are:

Taxable: This means you are paying tax on the money whether using the interest or not. It applies to all non-IRA CDs, savings accounts, money markets and dividend paying stocks and mutual funds, etc. If you’re not using this interest, you are still paying tax on it every year. It is important to understand if it makes sense to defer taxes or not.

Tax- deferred: These are your qualified retirement plans; a 401(k), 403(b), IRA. This money is deducted from current income so you do not pay tax on it when you earn it or while it grows. However, you will pay tax at ordinary income tax rates on all of it when you withdraw the money in retirement. Furthermore, you will be forced to start taking distributions and pay your taxes via (RMD's) the Required Minimum Distribution rule when turning 701/2 whether you need the funds or not. The government wants to start collecting their taxes after all those years of tax deferral.

Tax-Free:  As implied, no tax is due now or later. Most advisors agree it is good to be tax diversified and you should have some money in things
that are tax free. This can include things such as municipal bonds, Roth IRA's and life insurance cash value and/or death benefit.

While no investment exists that offers income tax deduction(401K's), tax-deferral and tax-free, there are several strategies that offer 2 out of the 3.

Strategies to create tax free income

Roth Conversion Strategies:

Converting traditional IRA's or 401K's to a Roth IRA is one strategy that might make sense as part of your retirement planning strategies. 

Roth Conversions:
Converting your traditional IRA or 401k to a Roth IRA may make sense for any number of reasons; if you have a number of years to work before retirement, expect to leave a substantial family legacy, expect higher tax rates in the future, expect to have an increasingly higher income moving you into higher tax brackets, have the ability to pay the taxes on the conversion.  A partial Roth conversion each year may work better to minimize the annual taxable income.

Back door strategy for contributing to a Roth IRA: Many people today are unable to participate in the benefits of contributing to a Roth IRA due to IRS contribution rules and limitations. But there is a way to contribute if you are not ordinarily qualified. First of all, you may want to contribute to a Roth If you have already converted all traditional IRA's and/or are above the income limitations for Roth IRA contributions. To participate in a Roth, you can make a non-deductible traditional IRA contribution, than immediately convert to a Roth IRA. Every individual's financial circumstances vary, so Roth conversions may or may not make sense for you. We'll help you understand the strategies and consequences of applying Roth conversions to your financial planning.

Permanent Life Insurance:

The Use of Permanent Life Insurance - The IRS provides for tax free distributions of cash built up in permanent life insurance policies when structured properly. Indexed Universal Life(IUL) or Whole Life policies may be an option to create a tax free income stream in retirement. Each individual's financial situation and needs must be considered in determining whether this makes sense as a strategy in their overall retirement planning.

Municipal Bonds:

A diversified portfolio of Muni bonds can provide tax free dividends for a portion of retirement income. 

Call us today at 973-285-1040 to review your financial situation and determine if tax free retirement strategies make sense in your financial planning.

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