As a financial advisor, I’ve often heard the phrase, “If it sounds too good to be true, it probably is.” However, in the case of creating tax-free income in retirement, this adage doesn’t necessarily hold up. Today, I want to share a real-life case study of how my team and I helped our clients, John and Jane, generate $100,000 of tax-free income in retirement.
Before diving into the specifics, let me address a common misconception. You might be thinking that the key to tax-free income in retirement is funneling all your savings into Roth IRAs during your working years. While Roth IRAs can be a valuable tool, it’s not always the best strategy for everyone, especially for those nearing retirement age. So, let’s explore a more nuanced approach.
John and Jane Doe came to us with a solid retirement plan, including $500,000 in a joint investment account, $650,000 in traditional IRAs, and $150,000 in Roth IRAs. They also had reliable Social Security benefits, with John receiving $3,200 per month and Jane receiving $2,000 per month, totaling $62,400 annually.
Our challenge was to help them maximize their income while minimizing their tax liability. Here’s how we did it:
Utilizing Social Security and Dividends: We started by leveraging their Social Security benefits and dividends from their investment account. By strategically combining these income sources, we were able to generate $72,400 annually, tax-free.
Strategic IRA Distributions: We carefully calculated IRA distributions to ensure they remained within a tax-efficient range. By withdrawing $11,600 from their IRA, we brought their total tax-free income to $84,000.
Optimizing Brokerage Account Withdrawals: To reach the desired $100,000 tax-free income, we withdrew $16,000 from their brokerage account. Importantly, half of this withdrawal represented a return of principal and was not subject to taxation, while the other half was non-taxable long-term gains.
The result? John and Jane achieved their goal of $100,000 in tax-free income without incurring any federal tax liability. Even though they had a substantial portfolio and reliable Social Security benefits, careful planning allowed them to minimize their taxes effectively.
We also emphasized the importance of long-term tax planning, encouraging John and Jane to consider strategies such as tax gain harvesting and Roth conversions. These approaches can further optimize their tax situation and reduce their lifetime tax liability.
Creating tax-free income in retirement is indeed possible with careful planning and strategic decision-making. By understanding the nuances of tax law and optimizing income sources, retirees can enjoy a comfortable retirement without the burden of excessive taxes.
If you’re nearing retirement or already enjoying your golden years, I urge you to take a proactive approach to tax planning. A qualified financial advisor can help you navigate the complexities of retirement taxes and create a personalized strategy with your needs in mind. The goal isn’t just to minimize taxes for one year but to optimize your tax situation over the course of your retirement.
Need help with your retirement?
Work directly with a licensed financial advisor at Root. Book a no-obligation initial call now so we can show you how we’ve helped hundreds of people just like you build a retirement they love.