How to live a tax free retirement

One of the biggest challenges to preparing for retirement is planning for taxes. After diligently saving year after year, if you haven’t anticipated your tax obligation, taxes could cost you up to 37% of your retirement savings. Can you live on a little more than half of your retirement investments? The more tax-saving strategies you can put into place now, the more money you will be able to keep later. Getting there, though, requires some planning ahead, so it is important to start early with tactics that will minimize your future tax liability.  

Contribute to a Roth 401(k) and Roth IRA

Most people use an employer 401(K) and Individual Retirement accounts to save for their golden years. An easy first step is to make sure that all your contributions are being made into the after-tax Roth bucket. This means that you will pay taxes on the money that you are putting into these accounts (your seed), but if, as planned, your investment grows over the course of your career, you will never have to pay taxes on the money you take out (your crop). In the end, this can save you thousands of dollars in taxes, and it will have a huge impact in preserving the money that you have worked so hard to make.  

Consolidate old 401(K)s

If you have worked for multiple companies over the course of your career, it may be wise to consolidate your investments. More often than not, when people switch jobs they forget to take their retirement savings with them. This is not necessarily a bad thing, but if you want to maximize your tax-free cash flow it is important to consider consolidating your assets. The reason being is that when you contribute to a 401(K) your employer will likely match your contributions up to a certain percentage. This is essentially free money to you, BUT those employer contributions will always be made into the traditional side of your 401(K). And, if you don’t move it, this will be money that is growing a tax liability for you down the road. Rolling over your old 401(K)s into an individual retirement account will let you move that taxable portion of your 401(K) into an IRA that you can then immediately convert to a Roth IRA. Although you will need to pay taxes that year on the amount that you converted (to avoid a 10% penalty), this will stop the burgeoning tax liability in its tracks. This way any money made from that point forward will be completely tax-free to you in retirement.  

Max out post-tax retirement accounts

You need to max out your post-tax investments to live a tax-free retirement. This is where having a financial advisor, who knows the system like the back of their hand, can be invaluable. If you are under the age of 50 in 2022, the IRS will let you contribute up to a max of $20,500 to the Roth portion of your 401(K) and up to $6,000 to your Roth IRA. You are allowed to contribute an additional $40,500 to your 401(K), but it will only count as an after-tax contribution. Unlike the $20,500 of after-tax money you have put into your Roth 401(K), which grows tax-free, this additional $40,500 will grow tax-deferred, meaning you’ll pay taxes on the growth when you take it out. But, if your plan allows you to, there is a way to convert this tax-deferred bucket into your Roth 401(K). This is called a mega backdoor Roth. It’s a strategy that takes some research, but it can significantly accelerate your ability to grow tax-free money for retirement. An important note about maximizing your post-tax retirement accounts is that you should always, always, always, take advantage of the “catch-up’ provisions if you can afford it. If you are over the age of 50, you can put an additional $1,000 into your IRA and an additional $6500 into your Roth 401(K) every year. This will only increase your ability to live tax-free in retirement. Like never being asked to lift something heavy again, getting old does have its advantages.  

Find alternative strategies for tax-free income

As you can probably tell, planning for taxes in retirement can be complicated. Apart from understanding how to maximize tax savings in your standard investment options, you should always be on the lookout for alternative strategies to fund a tax-free retirement. Products such as Roth Annuities, when appropriate, can solve an important piece of this puzzle by providing a stable monthly income for the rest of your life that will never be taxed. Other strategies, such as Indexed Universal Life Insurance, when funded correctly can build tax-free cash value that, subject to an upside market cap, is 100% protected from any losses! If started early, an IUL is one of the most powerful strategies to not only provide tax-free income in retirement but to protect your retirement savings from ever losing money in the market.  

Don’t let taxes cause your retirement to go up in smoke.

Minimizing what you have to pay Uncle Sam is a sure-fire way to make your money last longer. Maximize your contributions and look for alternative savings vehicles, like Indexed Universal Life Insurance, that fuel your retirement with tax-free dollars AND will never lose money in the market. Mission Critical FPI specializes in helping people keep more of their hard-earned money in retirement! Give us a call today.  

About the Author

  • Jeff Geraci

    Jeff Geraci grew up all over the world in a military family, and spent 5 years on active duty. While serving, he felt the tug between planning for financial independence with a limited income, and an all-consuming job. That’s when he decided that with a financial plan and a mentor, a service member could be successful in his career and finances! Military members are decisive, family-oriented, and really too busy to keep up with the changing financial world: the psychographics matched, people with military experience were an ideal community to serve!

Jeff Geraci

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