Tax Diversification in Retirement

There are four tax free income sources during retirement that you should be aware of and strategically employ to manage your annual taxes: Health Savings Accounts, Reverse Mortgage Income, Cash Value Life Insurance and Roth IRAs.

Health savings accounts are one of the most underfunded resources in retirement planning. Tax deductible contributions up to $6,550 per couple and a “catch up” provision of an additional $1,000 for those over age 55. You can also do a once in a lifetime transfer from your IRA to your HAS up to the annual contribution limit. You can make tax-free withdrawals for approved medical expenses and premiums. Health savings accounts may be the most valuable tax advantaged source of funds over a lifetime and especially in retirement. You’ll use it.

Reverse mortgage income is a housing solution for age 62 and older that may provide tax-free income for life by utilizing collateralized loans on your home equity. The program is called the home equity conversion mortgage (HECM) under HUD, and the FHA insures it. Reverse mortgage income has several flexible applications besides lifetime income that can really benefit retirees in planning their retirement.

Cash value life insurance also uses the collateralized loans from the policy to generate tax-free income. To maintain it’s tax-free status, the policy must be issued as a non-modified endowment contract and kept in force for the life of the policy insured. There are several crediting options available depending upon your risk tolerance.

Roth IRAs are a great funding option for those who are in a low effective tax bracket, but it’s also a great option to convert taxable qualified plans to. The conversion will cause an ordinary income tax event, but if you can remain in your tax bracket by converting your qualified plans over time it could be of great benefit to you. The ultimate goal is to convert taxable income to tax-free income before retirement.

One parting thought: none of these four tax-free income sources are includable in the provisional income test for Social Security benefits taxation. Some seniors conceivably could pay no tax if they used these four strategies.