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How to Avoid Paying Income Taxes in Retirement

Retirement: How to Avoid Income Taxes

The trick to avoiding income taxes in retirement is to have access to income in retirement that comes from both taxable and non-taxable sources (has already been taxed) of money.  Realize there is a difference between taking taxable income and paying taxes on that income.  While income may be taxable to you, you will only be subject to taxes on the income that exceeds your allowed deductions and exemptions.  So you may be able to draw income from taxable sources up to the amount of your allowed deductions and exemptions and not pay Federal income tax on that income.

Taxable Income

Your taxable income can include withdraws from tax deferred retirement accounts, earned income - income you perform work to earn - typically reported to you on a W-2 or 1099, and investment income.  Types of investment income include interest, dividends, and capital gains on money you invested in non-tax deferred accounts.  Recognize that your already taxed money invested is not taxable again when you take it out of an investment only the income that investment makes is taxable.  

Non-Taxable Income

Non-taxable income can include investment income from tax free vehicles like municipal bonds and ROTH IRA accounts.  As mentioned above, you can also take money, not income, tax free from money that has already been taxed like money invested in investment accounts (as opposed to tax deferred retirement account).

Social Security Income

Some of your Social Security benefits may be taxable if you receive additional income and your modified adjusted gross income (MAGI) is more than the base amount for your filing status.  

Avoiding Income Taxes

So how much taxable income can you take without paying Federal Income Taxes on it?  Part of the retirement strategy is often having your home paid for in which case you will likely take the standard deduction on your tax return.  In 2014 the standard deduction for a Married Couple Filing a Joint tax return will be $12,400 plus an additional $1,200 for a couple over 65 years of age. Personal Exemptions will be $3,950 per exemption in 2014.  So a married couple over 65 years of age in 2014 could take $21,500 in taxable income without paying Federal Income Taxes on it.  If you then take the rest of the money you need from money that has already been taxed or non-taxable income you could live without paying any Federal Income Taxes.  So the key is having access to both taxable and non-taxable income or cash.

Rising Income Tax Rates

Many people expect income tax rates to rise in the near future so your tax planning is even more important now.  In an environment where future tax rates are expected to rise you have to consider paying tax on your money now versus deferring it to the higher tax-rate future.  It may be ideal to have a portion of your retirement money in non-tax deferred accounts and some in tax deferred accounts so as to be able to pull from both sources and avoid higher income tax rates in the future. Take a hard look at putting money into a ROTH IRA, if you are able, and putting taxed money into investment accounts for use in your retirement.  Avoid the trap of depending solely on tax-deferred accounts in your retirement.

Planning your retirement strategy should include a review of your potential income tax situation which can get very complicated.  I would be happy to help look at your retirement plan and your options to see how Federal Income Taxes will affect you.

Income Taxes, Retirement, and Life can be difficult. If you would like help planning for retirement, email me to arrange an appointment to have a phone conversation.

Jeff Haywood, CPA
The CPA Superhero

My posts contain general information that does not fit every situation, they are not all inclusive, and as always for your tax situation everything "depends on facts and circumstances."  In addition, the information/IRS requirements are always subject to change.  So call me to talk about your specific facts and circumstances and what you want to accomplish.

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