Is “Tax-Free Retirement” Too Good to Be True?

Tax-free retirement—living a comfortable life in retirement without the obligation to pay income tax—comes as the result of planning and arranging your finances (following IRS guidelines every step of the way) so that when you retire, none of the money you receive is taxable—perhaps not even your Social Security income.

Tax-free retirement is good, and this article reveals how to make it happen.

Is Avoiding Taxes on Your Retirement Income Legal?

Reducing or avoiding taxes is perfectly legal. People take steps to reduce or avoid taxes all the time. They may donate to charity to avoid paying as much tax. They deduct their mortgage payments. They take legitimate business deductions. They may shift medical expenses, hoping to bunch expenses into one year and exceed the threshold for deductions that year. These are just a few of the legal tax-avoiding measures Americans take every day.

Many people even believe they have an IRA or a 401(k) to avoid paying taxes. But that’s a trap, because traditional IRAs, 401(k)s, and most other government-controlled retirement plans do not allow you to avoid paying taxes. They merely postpone tax day. We’ll talk more about that in a few minutes.

Over and over again courts have said that there is nothing sinister in so arranging one’s affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands.” — Supreme Court Justice Learned Hand

So while avoiding taxes is legal, evading taxes is not. Maybe you don’t report your income. Maybe you take deductions you’re not allowed. Or maybe you just tell the IRS to take a hike. That’s tax evasion.

But make no mistake: A tax-free retirement can be achieved legally, using IRS-approved methods.

Ways to Avoid Income Tax in Retirement

There are steps you can take before retirement to avoid paying income taxes in retirement.

Will traditional retirement plans allow you to avoid taxes in retirement?

What about 401(k) plans, IRAs, 403(b) plans, and other government-controlled retirement plans? Are they tax-exempt?

No, with the exception of Roth IRAs.

Advisors who promote tax-deferred plans as ways to avoid paying taxes are perpetrating one of the greatest hoaxes in America.

Countless individuals have discovered—too late—that their taxes weren’t avoided. They were merely delayed (“deferred”) until retirement—often when they could least afford to be hit with a big tax burden.

The Society of Actuaries explains the true value of tax deferral:

The point is that a fully deductible tax-deferred account produces the same effect as a Roth that is taxed at the beginning and no longer is taxed. In both cases, a certain fraction of your money is left to you after taxes, and if those tax rates are identical, it’s the same fraction of your money that is left to you. It doesn’t make any difference whether it’s taken away from you at the beginning or at the end.”

But isn’t it smart to defer taxes until you’re in a lower tax bracket? More and more experts are saying “No!” to that question, as well.

Ann C. Logue writes about saving for retirement in Forbes:

The benefits of tax deferral assume that future tax rates will be significantly lower than today’s. Given the deficits faced by the federal government and by most states, however, it’s difficult to say that that will be the case. If the marginal tax rate you’ll pay in retirement is higher than the one you face today, you’re better off paying the taxes now, according to recent research published in the Financial Analysts Journal.”

If you want to begin thinking about tax-free retirement, stop thinking your tax-deferred retirement plans will help.

The only government-controlled retirement plan that is tax-exempt is a Roth IRA. But the government restricts the amount you can contribute to a Roth, so you probably won’t be able to build up enough cash for a comfortable tax-free retirement. We’ll show you how to supplement your Roth in a minute.

What about money in the government-controlled plans you already have?

You are going to have to pay taxes on that money. Virtually every dollar you contributed to your government-controlled retirement plan was income on which you paid no income tax at the time. (Roth contributions are the exception.)

What will the tax rates be after you’ve retired? Many observers believe tax rates must go up due to government deficits and because of the increasing numbers of aging baby boomers receiving government benefits.

And there’s no guarantee your personal tax bracket will be lower in retirement. Many retirees we talk to say they’re finding themselves in a higher tax bracket.

Uncle Sam wants his pound of tax flesh. But you can pay your tax on the money one time, and never owe taxes on it again, if you move it into the proper financial instrument. We’ll tell you more in a moment.

Caveat: Money you withdraw from any tax-deferred plan increases your taxable income for that year. Don’t withdraw all your funds in one tax year, or you’ll blast your tax bracket for that year into the stratosphere. Work with a professional who can help you structure your departure from “tax-deferred” to “taxed-nevermore” so you pay the minimum tax necessary. That’s simply smart tax avoidance!

Other methods of reducing taxable retirement income

So the government isn’t much help when it comes to reducing your tax obligations, is it? Why should it be? The government wants every tax dollar it can legally get.

Where can you find good advice from someone who’s in your corner? It’s time to talk to a qualified life insurance professional.

A high cash value dividend-paying whole life insurance Policy may be the best way to accumulate wealth on a tax-deferred basis. You put in dollars on which you have already paid income tax. Then, as with a Roth IRA, you can access your principal and growth with no taxes due as long as your policy remains in force, under current tax law. This is accomplished through a combination of dividend withdrawals and loans against your cash value.

Life insurance offers other incredible tax advantages, which you can read about here.

High cash value dividend-paying whole life insurance policies are used by many, many knowledgeable individuals to fund tax-free retirement income streams.

What about your Social Security income? Will it be taxed?

Many people we’ve surveyed are shocked to learn that when they begin drawing Social Security, they’ll have to pay income tax on a major portion of it if they have other taxable income. And it doesn’t have to be much other income at all! Even taking the Required Minimum Distributions from their tax-deferred retirement plans can easily trigger taxes on Social Security income.

In the article, “Are My Social Security Benefits Taxable?” AARP explains: If you and your spouse file a joint return with a combined income between $32,000 and $44,000, up to 50 percent of benefits may be taxable. And if your combined retirement income is more than $44,000 annually, up to 85 percent of your Social Security income will be taxed as income.

But guess what? If you follow the rules, the money you take from your Bank On Yourself-type life insurance policy isn’t considered to be income.

First, dividends you withdraw (up to the amount of premium you’ve paid in) are generously characterized by the IRS as “return of premium paid” (in other words, not taxable). So to take money from your Bank On Yourself-type life insurance policy, it’s best to withdraw those dividends first. Then you borrow against your cash value.

And second, policy loans against cash value aren’t income. They’re just loans.

If your only income during retirement is from Social Security, plus life insurance dividend withdrawals and policy loans, plus less than $32,000 from other sources, your Social Security probably will not be taxed, under current tax law. (We have to say “probably” because there are exceptions to everything. So consult your tax advisor for specific advice based on your situation.)

Caution: Not All Permanent Life Insurance Policies Can Give You Worry-Free Tax-Free Retirement Income

Beware of books that promote the use of life insurance to create a tax-free retirement—if they recommend any form of life insurance other than dividend-paying whole life!

For example, in his book Tax-Free Retirement, Patrick Kelly advocates using universal life insurance. Others recommend indexed universal life insurance.

But whole life insurance gives you more guarantees than any other type of permanent life insurance. This article compares universal life with whole life, so you can decide for yourself.

Indexed universal life insurance has no place in a worry-free retirement plan. This article reveals 7 Reasons to Be Wary of Indexed Universal Life Insurance.

What Are You Waiting For?

The key to tax-free retirement income is planning. The time to start planning was probably yesterday, but today is the second-best time.

Request a FREE, no-obligation Analysis and find out how much tax-free money you could have in retirement. You’ll receive a referral to a Professional (a life insurance agent with advanced training on this concept) who will prepare your Analysis and Solution. There is no cost for this service, and no obligation on your part.