When you are no longer receiving a paycheck, reducing taxes becomes crucial to protecting retirement income. Retirees have specific financial goals, and minimizing tax obligations is one key to making money last longer.
Set yourself up for a stress-free retirement by considering one or more of these 10 tax-free investment options.
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1. Municipal bonds
Municipal bonds are one of the best tax-free investment options for retirees. Local governments issue these bonds, which are often exempt from federal income tax. In some cases, they’re exempt from state and local taxes as well.
This makes municipal bonds an excellent choice for retirees looking to generate income without increasing their tax burden. Plus, they are relatively low-risk, providing a steady stream of income.
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2. Roth IRAs
A Roth IRA is a powerful tool for growing investments tax-free. Unlike traditional IRAs, withdrawals from a Roth IRA are tax-free as long as the account has been open for at least five years and you are at least 59½ years old.
It’s worth noting that you cannot contribute to a Roth IRA unless you have earned income. So, you will need to do some work — even a part-time job — to use this option.
If you haven’t yet retired, consider contributing to a Roth IRA so you can tap the money tax-free once you finally stop working.
3. Roth 401(k) accounts
Similar to Roth IRAs, Roth 401(k) accounts allow you to withdraw funds tax-free in retirement. These accounts combine the benefits of tax-free growth and withdrawals with the higher contribution limits of a traditional 401(k).
As with a Roth IRA, you will not be able to make new contributions to a Roth 401(k) unless you are still working and earning income.
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4. Tax-exempt mutual funds
Investing in tax-exempt mutual funds is another way to reduce taxes during retirement. These funds typically invest in municipal bonds or other government securities that are exempt from federal taxes.
They provide retirees with a way to diversify their portfolio while keeping their tax liability to a minimum.
5. Health savings accounts
Health savings accounts (HSAs) offer a triple tax advantage for retirees with high-deductible health insurance plans (HDHP).
Contributions are tax-deductible. In addition, earnings grow tax-free, and you will not owe taxes on withdrawals you use to pay for qualified medical expenses.
As health care costs rise in retirement, an HSA can help cover those expenses without adding to your tax bill. If you have already been contributing to an HSA during your working years, it can be a valuable tax-free resource in retirement too.
Just note that once you enroll in Medicare — typically at age 65 — you are prohibited from making new contributions to your account.
6. Series I bonds
The earnings on Series I bonds generally are taxable. However, there is one major exception: Funds from these bonds that are used for some educational expenses escape taxation.
Even if you don’t use the bonds to fund an education, the interest earned on these bonds is exempt from state and local taxes. You also have the option of deferring federal taxes until you redeem the bond.
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7. Tax-exempt ETFs
Tax-exempt exchange-traded funds (ETFs) are similar to tax-exempt mutual funds. These ETFs focus on tax-exempt investments, such as municipal bonds, providing retirees with an easy way to invest in tax-free income sources.
8. 529 plans (for grandkids going to college)
While 529 plans are typically used for educational expenses, they can still play a role in a retiree's tax strategy. If you're planning to help your grandchildren with their college expenses, contributing to a 529 plan can allow your contributions to grow tax-free.
Additionally, withdrawals for qualified educational expenses are tax-free. Contributing to a 529 can be a tax-advantaged way to provide more financial help to your grandchildren.
9. Indexed universal life insurance
Indexed universal life (IUL) insurance policies offer retirees a special tax advantage. While the premiums are not tax-deductible, the cash value of the policy grows tax-free.
Additionally, the death benefit is also tax-free to your beneficiaries. This type of policy can make sense for retirees looking for a tax-efficient way to leave a legacy for their heirs while also having access to tax-free cash during their lifetime.
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10. Other types of life insurance
While you won’t benefit directly from tax-free income with a traditional life insurance policy, your heirs will.
The death benefit from a life insurance policy is typically tax-free, allowing you to provide for loved ones without worrying about taxes reducing their inheritance. This can be a crucial part of your estate-planning strategy, ensuring your wealth is passed on efficiently.
Bottom line
Finding tax-free investment options can be helpful to preserving your savings during retirement.The tax-free options on this list help retirees supplement their retirement income and minimize their tax burden.
Consider adding some of these investments to your retirement plan to set yourself up for a more secure and financially sound future.
Money tips that can work for everyone
No matter what your bank account balance is, there's always an opportunity to optimize and improve your finances. Here's a quick checklist of things you can look at today.
Focus on paying off your debt. Debt can hold you back from making progress with your overall financial well-being. Aside from cutting expenses, there are tools that can help you pay off debt faster like balance transfer credit cards and debt counseling.
Earning extra income can give you breathing room. If finances are tight, earning some extra money to supplement your income can make a huge difference. A new job is one option to consider, but if you're not ready to make a big change or already retired, a part-time side job could be a better choice.
Cut your expenses. It sounds painful and so not fun, but it doesn't have to be. Take a look at your biggest expenses because that's where you'll probably find the biggest savings. For example, auto insurance rates have been soaring so shopping around for a new insurance company can be the fastest way to cut your bill. Also, look for ways to cut your grocery bill (despite rising inflation).
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