Want to pay zero tax on your retirement income? Joe Anderson, CFP® and Big Al Clopine, CPA lay out how to make it happen with smart planning and the right mix of income sources. Discover the secrets to a tax-free retirement! Joe and Big Al dive deep into tax planning and Roth conversion strategies, smart financial planning, and tax diversification to make your retirement planning more efficient.
Download the Tax-Free Retirement Guide:
Important Points:
- 00:00 – Intro
- 00:28 – How to Build a Tax-Free Retirement Strategy
- 01:30 – Understanding the Three Buckets of Retirement Income
- 02:16 – How Tax Brackets Work and Why They Matter
- 05:05 – How Capital Gains and Investment Income Are Taxed
- 06:50 – Understanding How Social Security Is Taxed
- 09:26 – Smart Income Planning: Reduce Taxes and Maximize Cash Flow
- 10:34 – Roth Conversions: Turning Tax-Deferred Money into Tax-Free Wealth
- 17:30 – Other Ways to Create Tax-Free Income
- 21:32 – Real-Life Example: How to Pay Zero Taxes on $100,000 of Retirement Income
- 23:35 – Your Action Plan for a Tax-Free Retirement
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Transcript:
(NOTE: Transcriptions are an approximation and may not be entirely correct)
Joe: Do you want a tax-free retirement? Stick around. We will show you how to do it. Welcome to the show, folks. Show’s called Your Money, Your Wealth®. Joe Anderson here, CERTIFIED FINANCIAL PLANNER®, president of Pure Financial Advisors, with a big man sitting right over there. That’s Big. Al Clopine. Hello, Big Al.
Al: I’m pretty excited. Tax-Free Retirement.
Joe: Tax-free retirement. Think it’s possible?
Al: I think it is possible. I think it is. If you do the planning.
How to Build a Tax-Free Retirement Strategy
Joe: We’re gonna dive in. That’s today’s financial focus. $525,000, folks, that’s what an average American pays to the IRS over their lifetime. The average American 525,000. Hey, we wanna figure out strategies to reduce this, and I think there’s a misnomer because when people approach retirement or in retirement, they think they’ll be in a significantly less tax bracket and pay very little in tax.
That’s true for some, but not for most. You have to get the strategies in place to reduce this tax bill. Let’s bring in Big Al to show us how.
Al: Alright, to get a tax-free retirement, we gotta go over some basics and get into strategies. So first of all, we’ll talk about how income is taxed, and then most importantly, we’ll get into tax-free income and then tax breaks over and above tax-free income. Tax breaks that you can take to reduce your taxes sometimes all the way down to zero.
Understanding the Three Buckets of Retirement Income
Joe: A lot of us need assets to produce income in retirement, and there’s three different pools of money that you can invest in, and they’re all taxed differently, such as like your tax deferred accounts, your retirement accounts. So when you take dollars from that to live off of in retirement, they’re going to be taxed at ordinary income rates.
Then you have your brokerage account. This could be a stock, a bond, and mutual funds, something that’s outside of your retirement account. You pull those dollars out to create income. This is taxed differently. It’s at a capital gains rate. And of course we got the tax-free bucket here. Those are Roth IRAs, our favorite. So when we think about where your assets are held, you might wanna think about a strategy on how you create the income from these different pools to reduce the overall tax burden. But before you even get into strategy, you gotta figure out exactly how those tax brackets work.
How Tax Brackets Work and Why They Matter
Al: The same lower tax rates that we got in 2018. So they continue indefinitely. So we’ve got a 10% bracket, 12%, 22, 24, all the way to 37. These are a lot lower brackets than what we had before. So interestingly enough, married filing joint was $30,000. But the big beautiful act, we didn’t even get it on in time. It’s actually 31 5, so a little extra deduction there.
Now if you’re blind or over 65, you get another couple thousand dollars. If you’re single or 1600, do $1,600 per person for a married couple and. You get an extra $6,000 per person if you’re over 65 just on top of all these numbers as a deduction. And of course these phase out, if single starts phasing out about 75,000 marriage starts phasing out about one 50. But a lot of deductions some existing and some higher and better.
Joe: Yeah. And I think with those tax credits, depending on what that income shows up on your. Your tax return, right? Because you can manipulate if you will, or you can strategize in such a way to keep dollars off your tax return, depending again how you pull the money.
Another thing that is very confusing the most is that this is like the brackets L just went through this. You got a 10% all the way to the 37% tax bracket. But let me run a quick example so you understand how these brackets work. ’cause they’re marginal. So what, let’s say I’m married and I make. Let’s call it a hundred thousand dollars a year.
So my taxable income on my tax return shows $100,000. So how you look at this is the tax tables. So I look, alright, there’s 96,000 to 2 0 6. A hundred thousand dollars falls in this 22% tax bracket. So a hundred thousand dollars, that means I pay 22%, but it’s not on the full a hundred thousand dollars if I think about it, right?
96,000 to 550, so I’m just gonna round that up to $97,000. Is the top of the 22% tax bracket, I make a hundred thousand dollars. So out of that a hundred thousand dollars, only $3,000 is going to be taxed at that 22% rate. So how it works is that a little bit is gonna be taxed at 10%, so zero to 24,000, then 24 to the 97,000 will be taxed at 12, and then that remaining $3,000 will be taxed at 22.
So if I understand how these brackets work and where my taxable income falls, then I can start maneuvering my assets in such a way or be having a conscious effort as I’m taking money from my portfolio where they fall on the overall brackets so I can reduce that tax as much as I can.
How Capital Gains and Investment Income Are Taxed
Al: Now capital gains work the same way in a sense. So this is when you sell a stock or bond at a gain mutual fund outside of a retirement account, right? So this is non-retirement accounts. You sell it at a gain, you held it for at least a year. Real estate works this way too, you. You get a special capital gain treatment and that tax is lower than the ordinary income rates that we just looked at.
So when you’re looking at like single up to 48,000 of taxable income, married, double that about 97,000, there is no tax on that capital gain. Now, if you go over. A thousand dollars, then that a thousand dollars is taxed at the next bracket, which is 15%, but not the whole thing. And then as you get much higher capital gains, you can get up to 20%. Joe, there’s also a net investment income tax credit as well.
Joe: Yeah. What we’re trying to stay here in that 0% tax bracket, there’s such a huge window. If I’m married, that’s a, again, another a hundred thousand dollars of capital gain plus my standard deduction. So there’s a lot of room for you to basically sell assets that you have in a brokerage account and pay zero tax on those dollars.
Like Al said, this is the net investment income tax. So these are for higher income earners. If you make 200,000, single two 50, if you’re married, you gotta attack on another 3.8. So the higher income that you’re in, that capital gain treatment gets even higher. So we want, again, to take a look at, all right where do I fall on that tax return?
How much income do I want to derive? What are my other fixed income sources? Then I can really control the overall taxation on those assets. I think another very confusing component of tax Al. Is Social Security tax.
Understanding How Social Security Is Taxed
Al: So yeah, Social Security. Talk about something that’s complicated. So it used to be Social Security income wasn’t taxed at all, and then they came up with a way to tax it.
But it depends upon how much your income is. So you gotta look at your adjusted gross income, right? You add your tax. Income you. You do your excluded foreign income, and then half of your Social Security tax benefit, add those together. That’s what’s called your provisional income and your provisional income.
Then you can go to the table and figure out how much of your Social Security is gonna be taxed. It’s not the tax rate, Joe, it’s just how much of it is going to be taxed?
Joe: Yeah. You have to figure out that provisional income first once you figure out the provisional income. Then you go to this tax table, right?
So there’s many tax tables here. So this is your Social Security tax table to see if my provisional income, if I’m married again, is between zero and $32,000. Guess what? 0% of my Social Security’s going to be subject to federal income tax. This is just on a federal basis. Now, if that provisional income is above 32,000 to 44.
Then 50% of that is going to be taxed, and then on top of that, then 85% of my tax, if I’m over 44,000. So there’s ways to reduce the provisional income, and if I can reduce my provisional income and still get high cash flow right, I could pay zero tax potentially on my Social Security, or maybe 50% of my Social Security is subject to tax, so I’m receiving more cash.
With less tax. So it’s all the game of numbers on how you maneuver the assets as you create that income.
Al: It is complicated. And of course then there’s things that can bump your taxes up, so be aware of them. Like required minimum distribution. So those start at age 73. That’s where you have to take money outta your IRA and 401k, and you have to start paying tax on it, and there’s tables to figure out what the minimum you take.
Now you may sell some investments, you may sell business, you may sell real estate. That’s in general capital gains, lower tax rate, but still gonna add to your overall tax. Bill, employee stock benefits. Joe, that’s a big one. I mean, there’s stock options, there’s restricted stock, there’s deferred comp plans, all kinds of ways to increase your tax.
Joe: Yeah. And it just spikes the bracket. So you gotta be careful and have to have a strategy as you look at these tax bump items that come through. Clear as mud, right? A lot of things to go over. A lot of things to understand as you approach retirement, as you’re creating that retirement income, there’s a lot of strategies that you can think about to reduce that overall tax burden.
Smart Income Planning: Reduce Taxes and Maximize Cash Flow
If you can reduce the tax burden, guess what? That asset just continues to stretch for you a lot longer throughout retirement. Spend a little bit more, pass a little bit more to the kids, give a little bit more to charity, whatever that you want. This is all about controlling the dollars that you own. If you want more help, we got a brand-new guide for you.
Guess what? It’s called the Tax-Free Retirement Guide. You wanna learn a little bit more about taxes and how to create that tax-free income. That’s where to go. Hey, when we get back. We’re gonna talk about different ways to create those dollars that will come out tax-free regardless of what tax bracket you’re in.
Joe: Hey, welcome back to the show called Your Money Your Wealth. Go to your money wealth.com. Click on that special offer. It’s our Tax-Free Retirement Guide. If you’re just joining us, we talked about tax brackets, ordinary income brackets, capital gains, tax credits, all sorts of different things. If you wanna understand taxes a little bit more, you could download our guide. It’s our Tax-Free Retirement Guide. How would you like to have a tax rate retirement? Let’s see how you did on the true false question to get you there even further.
Roth Conversions: Turning Tax-Deferred Money into Tax-Free Wealth
Al: One way to create tax-free income is with a Roth IRA. True or false? Of course that’s true. And Joe, this may be your favorite topic to talk about. So why don’t you explain it to.
Joe: Sure. I’d love to, Alan. Thank you. So tax deferred assets. So your retirement accounts still a lot of people don’t understand how to do this or how to do it. If I have a retirement account, an IRA, 401k, 403(b), TSP, set plan, simple plan, whatever, it’s a pre-tax account that grows tax deferred and I wanna pull those dollars down in retirement. But when I pull those retirement dollars out, I am taxed at ordinary income rates.
So the more dollars that I pull out, the more taxes that I pay. Great plan because I got the deduction going in. I got the nice tax deferral. I never had to pay tax on those dollars, but when it comes time to spend them, that’s when I have to pay the tax. For some of you, a strategy might make sense depending again on what tax bracket that you’re in to say, Hey, I might want to take a little bit more from this account.
And pay that tax. But I wanna move it up into a tax-free environment. So you can take a retirement account and you can move it into a tax-free environment called a Roth IRA. I have an IRAI can move it into a Roth IRA. Just know that any dollar that you move will be subject to tax, but then all of those dollars will grow tax-free.
So if I’m in that 22% tax bracket. I might wanna utilize the entire bracket, P 22% on whatever distribution that I want to move, but then those dollars will continue to grow for me, my spouse, my kids, all tax-free. So a Roth conversion, there’s contributions that I think a lot of us are familiar with. Hey, I can make a dollar, $5, 5,000, $7,000 contribution into some mutual funds.
Have it grow tax-free. I have to qualify for that. In regards to income, a Roth conversion, all you need is a retirement account. If I make a million dollars, I can do a conversion. If I make $0, I can make a conversion. So I want to have a little bit more balance in these accounts because this will really gimme the control that I want long term when I retire.
Al: Such a good point. And I just kind of wanna reemphasize, so the Roth conversion. It doesn’t matter if you’re working or not. You can be retired, you can be 20 years old, you can be 90 years old, as long as you have money in an IRA or 401k. You can do a conversion. You can do any amount you want to. There’s no limitation on amounts.
Your limitation should be what bracket you’re in and what makes sense for you. But anyone can do it and actually probably should consider it each and every year, depending upon your situation.
Joe: Alright, we talked about a Roth, so that will gimme tax-free income. What other things can I do to gimme tax-free income?
I don’t know. How about tax-free municipal bonds so I can purchase a bond? Again, a bond is a loan. It’s a safer investment than a stock. A stock is ownership in a company, a bond. I’m lending that money to a company or a municipality in this example. So I give that municipality a thousand dollars or I could give that a thousand dollars to a corporation.
Okay. Let’s say assume hypothetically that the municipality is going to pay me 4% to use my money, and the corporation will pay me 4% to use my money, so I can use a tax-free bond or a corporate bond. 4% is the same, so my income for that year is gonna be $40 at that a thousand dollars fees value. But when I received that.
$40 and it goes into my checking account. Guess what? There’s no tax, zero tax, pretty good. So $40 is all mine when I buy that taxable bond if I’m in a 22% tax bracket, $9 roughly is gonna go to the IRS. So I’m left with $31, so I really don’t get a full 4%. If you look at it this way, I get about a 3.1% rate of return if I’m looking at a tax equivalent yield. So what other things can we do Al, in regards to tax-free income?
Al: We got a few. So let’s talk about health savings account. So you have to be employed, you have to have a high deductible health insurance plan, but if you have that, you can actually put money into a health savings account and you contribute pre-tax dollars.
So you don’t even have to pay tax on those dollars. You get a tax deduction, right? Reduces your salary that you pay tax on. There’s no taxes on earnings, and it’s tax-free withdrawals as long as you use it for medical expenses. And let’s face it, as we get older, we probably need a little bit more money for medical, so you get a tax deduction, it grows tax-free, you pull it out for medical expenses that you would have anyway. And don’t pay tax on it. So it’s a great way if you qualify, if you have the right health insurance plan to be able to put money into it.
Joe: Alright, here’s another one. A 121 tax exclusion, 121 tax exclusion or other words? Home sale exclusion. Your primary home. So how does this work and how is that tax-free?
If I’m single. $250,000 of that game is exempt from tax. If I’m married, $500,000 pretty good. So if I wanna downsize my home, I could take $500,000. Let’s say I buy my home for 500,000 hypothetically, and it’s worth a million dollars today. I sell it. I have a $500,000 gain. I would normally have to pay tax on a capital asset of that game, but not if it’s my primary residence.
I can exclude that full 500,000 tax-free back into my pocket. Two things that you gotta do. It’s gotta be your primary and you gotta live in that primary for two outta the last five years. If you’ve lived in your primary residence, two outta the last five. You can exclude two 50 or 500 and you can continue to do this.
It’s not a one time shot. If I buy another primary residence living at two outta last five and it has a gain of whatever I can ex exclude, excuse me, exclude up to 500. Or two 50.
Al: One more quick thing. If you’ve got rental property, you can do a 10 31 exchange. There’s certain rules you gotta follow, but you can buy a replacement property for the one that you sold and defer that gain and not pay any tax currently.
Joe: Alright, if you want more help, dive in a little bit deeper. Do some studies, go to your money wealth.com, click on our special offer. It’s our Tax-Free Retirement Guide. Tax-Free Retirement Guide. Figure out how to get more tax-free dollars. Into your pocket. You deserve it.
Joe: Hey, welcome back. Shows called Your Money, Your Wealth®. We’re talking tax-free retirement. Folks. Go to YourMoneyYourWealth.com. Click on our special offer this week. It’s a brand new guide. It’s called Tax-Free Retirement Guide. All right, let’s see how you did on that true false question.
Other Ways to Create Tax-Free Income
Al: A QCD can satisfy an RMD. True or false? That’s true, but what does that mean? A QCD? That’s a qualified charitable distribution, so that’s a qualified charitable distribution actually out of your IRA, directly to a charity, and it can satisfy your RMD, your required minimum distribution. The QCD Joe, you can do it starting at age 70. The RMD starts at age 73 currently.
Joe: Yeah, if you look at it like this, here’s me I got my IRA and I give to charity every year. And so what we see sometimes is that you have to give the RMD when you give the RMD or take your RMD, right? You pay taxes on those dollars. That shows up on your tax return.
That’s part of your adjusted gross income and so on. So depending on what tax bracket that you’re in, you probably wanna just bypass. Taking the RMD and not having that dollar show up at all on the tax return. So you just tell your custodian, Mr. Custodian or Mrs. Custodian, Charles Schwab, let’s say, Hey Chuck, I don’t wanna take my RMD up to a hundred thousand.
Maybe you give 10,000 to charity in your or $20,000 to charity each year in your RMDs 20,000. You go, all right, just give it to the charity so it bypasses the IRS altogether. Al, why is that a good thing?
Al: It’s a great thing, Joe, particularly with the higher standard deduction. So a lot of people nowadays are not itemizing.
So this is a way, if you’re not gonna itemize anyway and not get the benefit for the charitable deduction, then why not keep the income part, the RMD part off your income and not have to pay tax on it.
Joe: If you have stocks, bonds, mutual funds, things that are outside of your retirement account, there’s something that’s called tax lost harvesting.
This is another great strategy. Markets are volatile. Stocks go up, stocks go down. So if you have stocks that are up in value, some people, oh, I don’t wanna sell that. I have too much gain. I don’t want to pay tax. And then when the market goes down, it’s like, no, I don’t wanna sell that. It’s gonna come back.
Okay, I get that. That’s really good. Prudent planning and in some degree, but when you have to start selling assets to live off of, you might wanna think a little bit differently and have a strategy around how you’re managing those dollars outside of retirement accounts. If markets go down and you have a loss, it might make sense to sell that security but not go into cash, buy another security that’s similar in nature.
You lock in that loss on your tax return. Then if you have a gain that loss that you just took offsets and you have zero tax losses will offset gains dollar $4 from a capital asset perspective. Zero capital gains pretty good.
Al: Yeah, and I think there’s a lot of confusion about how this works because there’s the $3,000 that you can take each year against ordinary income.
This is capital gains go against capital, losses, dollar for dollar. And here’s the thing, if you sell a stock at a loss and you got a big loss and you don’t need it, all it carries over to next year. And actually it, it continues the rest of your life.
Joe: All right, here’s another one. This takes a little bit of effort than selling a couple of stocks or mutual funds.
This is packing up the old house and moving to another state. What’s your favorite, Joe? I was gonna ask you that big Al. If you had to pick any of these states, where
Al: would it be? I think I might, I probably would pick Washington, I guess, although I don’t like the clouds, so, big Al, I think. I think I’d pick Washington Big.
Joe: Al’s going to Washington.
Al: Yeah. How about you?
Joe: Yeah.
Al: Do you wanna go to Florida?
Joe: I went to school in Florida, so I’ve already lived there. You know, it’s a little muggy. Got some bugs, you know? I don’t know. I lived next to South Dakota. I’m not sure if I wanna go back to the Midwest. I don’t know. I think I’m gonna go to Texas.
Al: I would say one thing though, here be a little bit careful because even though they don’t have income taxes, they may have higher property taxes or higher gas taxes, or higher sales taxes. So just be aware of what you’re getting into.
Real-Life Example: How to Pay Zero Taxes on $100,000 of Retirement Income
Joe: Alright. Let me run an example. How does a couple make a hundred thousand dollars and not pay any tax?
So we got Bob and Betty, so they have a hundred thousand dollars cash flow coming to them. What does that a hundred thousand dollars consist of? Let’s look. We got $50,000 is combined Social Security for Bob and Betty. They have some, they sold some stocks, mutual funds that they had in their brokerage account of about $20,000.
They had some money in a Roth IRA. They took $20,000 from there, and then they took another $10,000 from their 401k. So you add all those dollars up, that equals a hundred grand. So they have that a hundred thousand dollars sitting. In their account and they’re living off that next year, they go to Big Al, the CPA to do the taxes.
Al, you’re gonna have to understand a few different things to figure out what their taxes are gonna be. First is that provisional income? So what’s provisional income again? Alright, it’s half of your Social Security plus your adjusted gross income. Their provisional income is only $55,000 because you take half.
The Social Security is 25,000 plus everything else. Will be 55. You put that in the old calculator and you’ll find out only $15,300 of the 50 is going to show up on the tax return. So a total a GI will be $45,300. And then you have a standard deduction of 33,200.
Al: It’s gonna give you about $12,000 of taxable income, so no, no tax. And why is that? Because your taxable income in this example is about $12,000. Your long-term capital gains are 20,000. So your taxable income is lower than your capital, long-term capital gains, which means all of your income is taxed at the capital gain rate. And what’s that capital gain rate when you’re in the lowest brackets? Oh yeah, it’s zero. So you don’t pay any taxes in this example.
Your Action Plan for a Tax-Free Retirement
Joe: Alright, so it’s understanding capital gains rates, it’s understanding provisional income, it’s understanding ordinary income and where you fall on those overall brackets. And as you’re taking distributions from your IRA, your Roth IRA or your brokerage account.
And what that combination looks like with your Social Security is gonna determine your taxes. So having a strategy every year on how you’re pulling those dollars out. Could lead to 0% in tax. So that’s why planning upfront is so important to make sure that you get things dialed. So I want you to take action.
Look at those withdrawals, manage those brackets, looking at long-term rates and your Social Security. Alright, I know we threw a lot at you today folks. Hopefully enjoyed the show. Hopefully you learned a couple nuggets. If you want more help, you know where to go, just go to your money wealth.com. Click on that special guide. It’s our free re Tax-Free Retirement Guide, and it’s also free. It’s a free Tax-Free Retirement Guide. How about that? For a play on words, go to YourMoneyYourWealth.com. Click on the special offer and enjoy that tax-free retirement. For Big Al Clopine, I’m Joe Anderson. We’ll see you next time.
IMPORTANT DISCLOSURES:
• Investment Advisory and Financial Planning Services are offered through Pure Financial Advisors, LLC. A Registered Investment Advisor.
• Pure Financial Advisors, LLC. does not offer tax or legal advice. Consult with a tax advisor or attorney regarding specific situations.
• Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance.
• Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values.
• All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy.
• Intended for educational purposes only and are not intended as individualized advice or a guarantee that you will achieve a desired result. Before implementing any strategies discussed you should consult your tax and financial advisors.
CFP® – The CERTIFIED FINANCIAL PLANNER® certification is by the CFP Board of Standards, Inc. To attain the right to use the CFP® mark, an individual must satisfactorily fulfill education, experience and ethics requirements as well as pass a comprehensive exam. 30 hours of continuing education is required every 2 years to maintain the certification.
AIF® – Accredited Investment Fiduciary designation is administered by the Center for Fiduciary Studies fi360. To receive the AIF Designation, an individual must meet prerequisite criteria, complete a training program, and pass a comprehensive examination. Six hours of continuing education is required annually to maintain the designation.
CPA – Certified Public Accountant is a license set by the American Institute of Certified Public Accountants and administered by the National Association of State Boards of Accountancy. Eligibility to sit for the Uniform CPA Exam is determined by individual State Boards of Accountancy. Typically, the requirement is a U.S. bachelor’s degree which includes a minimum number of qualifying credit hours in accounting and business administration with an additional one-year study. All CPA candidates must pass the Uniform CPA Examination to qualify for a CPA certificate and license (i.e., permit to practice) to practice public accounting. CPAs are required to take continuing education courses to renew their license, and most states require CPAs to complete an ethics course during every renewal period.
