Planning for a tax free retirement income is critical if you want to keep cash outflows to a minimum in your golden years. Besides a pesky outflow, remember that the more your taxable income is, the more you will pay taxes on your social security withdrawals as well. So, if you have a portfolio set up for your retirement income, it is high time you plan tax-free income streams into that retirement portfolio.
Tax free retirement ideas – Where can you invest?
A Roth IRA is the best tax-free income that you can plan for in your retirement. The advantage with Roth IRA is that your contributions are taxed as you add to your investment, meaning that your withdrawals are tax free. The cherry on the cake here is that investment returns earned on your already taxed contributions are also tax-free when you withdraw them, in your later years.
As you can imagine, this can be a significant way to generate attractive tax free income streams for when you are retired. The downside to Roth IRA is that contributions are capped in a year, meaning that you can’t contribute more than $5,500 a year (if you are aged 49 and less) and $6,500 a year (if you are aged 50 or more). However, you must try to max out these contributions to increase your tax free benefits when you are ready to cash out your Roth IRA account, in your retirement years. They key is to also wisely invest your Roth IRA in good but safe vehicles.
You can learn more about Roth IRA, at Money Looms, here.
Single Premium Immediate Annuities
We don’t recommend variable annuities but a single premium immediate annuity is definitely worth a look at. If your Single Premium annuity is funded by a Roth IRA for example, withdrawals are tax-free. Even if it is not funded by a tax-free source, it can still mean that you pay less taxes on the returns that you get, especially lesser than conventional investments in equities for example.
A single premium annuity is when you invest a large chunk of money, like say $25,000, into a guaranteed insurance product that will payout a fixed monthly income for as long as you live. If you were 50 years old when you invested the $25,000 mentioned above, you could be entitled to a $120 a month payout for as long as you live. If you manage to live up to 80 years of age, you would have received a total of $43,200 before you are laid to rest.
The risk however is that your early demise will mean that you wouldn’t have had enough time to earn any interest or even your principal investment.
Investments in Municipal Bonds and Funds
Bonds get a bad rep because they never really earn much. If you aren’t interested in the very low paying treasury bonds, consider municipal bonds that have managed to return 3% to 4% in the past year. (2016). Besides the respectable return on investment, you get the larger tax-free benefits when you cash out of these investments.
If you know nothing about municipal bonds, look at the Fidelity Intermediate Muni Income fund for a start. In the past one year, it has returned a respectable 2.5%. The downside to Municipal bonds is that funds that trade in municipal bonds are subject to volatility, thanks to the high level of leverage used in these funds. Though the Fidelity fund returned 2.5% over the past year, one has to consider that it has returned only 2.6% over the past 5 years.
Investment in a Health Savings Account (HSA)
You must look into HSA if you think you are almost certainly or most probably looking at fairly significant medical expenses in your retirement years. Using the HSA is more of an exploitation of a loophole rather than directly using it as a retirement plan that will result in tax benefits But, it is a 100% legitimate approach and approved by the IRS. Just make sure you conform to the requirements set forth in IRS publication 969. HSA is something that you must look to invest in if you know that you will inevitably run into medical expenses in your retirement or even in the years leading up to your retirement.
To use the HSA tax-free loophole, all you need is to signed up for a health plan where your deductible is at least $1,250 if you are an individual and $2,500 if your health plans caters to your family. If you meet this condition, you can open a HSA and contribute up to $3,250 a year (individual) or $6,450 a year (family). We are talking about investing pre-tax dollars that also grow tax-free.
Besides benefits like investing HSA funds in a mutual fund or other marketable security, you have the huge benefit of withdrawing money anytime to pay for medical expenses, without paying accompanying taxes.
However, HSA only makes sense when you think you will need to withdraw money to pay for medical expenses as you will get hit with taxes if you withdraw the money for non-medical purposes. If you are 65 years and younger, you will have to pay 20% penalty fee and also taxes if you withdraw for non-medical expenses. After 65, you only pay taxes and not the penalty, for non-medical withdrawals.
Once again, HSA is ideal if you already know that you are going to run into medical expenses in the future. A word of caution though. HSA accounts are new and have not come under a lot of regulation. Lack of regulation and monitoring means that HSA account managers can possibly apply annoying charges like account maintenance fees and miscellaneous fees that can eat into your investment. Just be wary of such fees when you sign up for a HSA that is managed and invested in instruments.
Please read through the Money Looms retirement section for more insights into retirement investing and planning.