Taxes can be a huge burden at any stage of life. But during retirement, they can be particularly problematic.
Many retirees find themselves with a fixed income made up largely of Social Security. So, minimizing taxes in retirement by planning ahead could make your senior years a lot less stressful. With that in mind, here are three options for accessing tax-free income when you need it most.
1. Save in a Roth pension plan
It’s easy to see why traditional 401(k) plans and IRAs appeal to so many people: you get tax relief on the money you invest in them. But if you’re willing to give up that initial tax relief, you’ll get it. tax-free investment gains, as well as tax-free withdrawals, when you save for retirement in a Roth IRA or 401(k) instead.
Now, for many years, Roth IRAs have offered the distinct advantage of being the only tax-efficient retirement plan to not impose minimum required distributions. But from 2024, Roth 401(k)s will not impose them either.
2. Fund a health savings account
If you are enrolled in a high-deductible health insurance plan, you may be eligible to contribute to a health savings account, or HSA. Now, the only way to enjoy tax-free withdrawals from an HSA is to use your money for healthcare expenses. But it’s an expense that will likely increase during your retirement anyway.
Fidelity estimated that the average 65-year-old couple retiring last year faced $315,000 in health care costs throughout retirement. And if you have a lot of health issues in retirement, you might end up spending even more. Funding an HSA could allow you to access tax-free income to cover some (or, ideally, most) of your medical expenses as a senior.
Now one thing you should know about HSAs is that once you reach 65 you can use your money for any purpose without incurring a penalty – it doesn’t have to be to cover a health care bill. But withdrawals made for non-medical purposes will be be subject to tax, so if you want access to this tax-free money, be sure to earmark it for healthcare expenses. Chances are you need it anyway.
3. Invest in municipal bonds
Bonds tend to be a great investment for retirees because they are quite stable and can generate a predictable stream of income. Bonds generally pay interest twice a year, and if you invest your money in municipal bondsthis income will be exempt from federal tax.
Additionally, if you purchase municipal bonds issued by your state of residence, you will also not be subject to state or local taxes. Remember that the tax exemption of these bonds only applies to interest payments. If you sell municipal bonds for a profit, those gains may be subject to tax.
Reduce the tax burden
Money inevitably becomes tight for many people once they retire. Increasing your tax-free income could save you a lot of worry and stress, and it could give you more purchasing power throughout your senior years.