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Do yourself a favor and learn how to Minimize Taxes in Retirement.

Smart tax decisions can have a considerable impact on how much money retirees will have in the golden years. One of the best ways to boost returns for clients, according to a study published by Morningstar, is to invest and withdraw retirement funds in a tax-efficient manner.

Doing this can boost retirement income by up to 4%. That means that for every $100, retirees could have an additional $4 in income if certain tax strategies are implemented.


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It’s critically important that individuals who regularly invest for retirement understand that as our debt continues to skyrocket, tax-hungry legislators will eventually have to pay that debt down by increasing income taxes significantly.

If you are interested in knowing how to minimize your taxes in retirement, here are five methods that will help diminish your tax liability on your retirement income.


Your Social Security


If you want to avoid paying taxes on your Social Security, you need to follow certain stipulations. This includes making sure that your income stays below certain levels ($25,000 if filing as an individual, $32,000 if married filing jointly). But there’s a formula you need to know about, and it’s not as simple as “if your income goes over this level, you will be penalized.

Even if you exceed these limits, you may not need to pay taxes on all of your benefits. You might be able to get away with half or 85% of the taxes


A Roth IRA


The Roth IRA is a popular choice among those looking for tax-free income in retirement. The Roth IRA offers a lot of flexibility as well. You won’t pay taxes on your contributions coming out of the account (since you paid taxes on them on the way in) or the earnings on those contributions, and experts love it.

One of the great benefits of a Roth IRA is that withdrawals don’t create taxable income, which means you can combine it with other retirement accounts that do. For example, if you have a traditional 401(k) account as well as a Roth IRA, your withdrawals from your Roth IRA won’t be taxed as income.

A Roth 401(k)


The Roth 401(k) has some perks that the Roth IRA doesn’t. It allows you to withdraw money in retirement (after age 59 1/2) tax-free after owning the account for at least five years. In some circumstances, it may be a better investment option.

Additionally, a traditional 401k gives you a company match for your retirement savings. This is free money to give you a head start in savings for your retirement. That said, the company match is placed in a Roth 401K, which means you don’t get the special Roth tax perks.

The Roth 401(k) does have drawbacks, however. There are no minimum distributions with the Roth IRA, for example, and the Roth 401(k) requires them after a certain age. That’s just one key difference. But before you decide on the Roth 401(k), remember to consider all of its differences.


A Traditional IRA


Retirees who withdraw money from traditional IRAs with pre-tax contributions are often taxed. However, if you earn less than the standard deduction ($12,400 for individuals and $24,800 for married filing jointly in 2020) you can avoid taxation.

Although this is not a lot of income to live on, combining a traditional IRA or traditional 401(k) with a Roth account can allow you to take advantage of this neat tax system. Tax-free income is possible if you properly plan it! You can also get Social Security benefits tax-free, too.


Whole Life Insurance (Participating)


Another popular strategy for creating tax-exempt retirement income is to use a participating whole life insurance policy. With this type of insurance, a portion of your premiums is placed in a cash value account where you will earn guaranteed tax-deferred interest along with dividends from the insurer.

Whole life insurance is considered a better life insurance tool for retirement because it earns dividends and guaranteed interest. These dividends can be used to buy paid-up life insurance, which also earns dividends and interest thereby allowing the policyholder to accumulate substantial wealth over time and there are no age restrictions for withdrawing cash and there are no minimum distribution requirements.

When the time comes for the policyholder to withdraw funds for retirement, rather than taking a taxable withdrawal, they can instead take out annual policy loans that are not considered income by the IRS.

Additionally, the loans do not have to be repaid to the company however, they will deduct any outstanding loans and interest from the death benefit when you die.

Whole life insurance policies are perfect for people who like predictability and are willing to pay for it. One of the bonuses is dividends, which are similar to annual premiums paid by mutual insurance companies to their customers. These dividends can be used to pay the premiums, increase the cash value of the policy, or simply take the money.


The Bottom Line


Avoiding taxes on your retirement income can be difficult to do without proper planning. If you’re planning to curtail your lifestyle to avoid taxes, it may not be worth it.

However, the earlier you begin making plans for this – for example, by withdrawing assets from a Roth IRA or Roth 401(k) – the more freedom you’ll have in retirement and the less hassle you’ll have to worry about because your retirement income won’t be severely diminished by income taxes.


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Curt Gibbs