Loving senior couple dancing on the balcony. Happy man and woman spend free time together. … [+] They are at home.
Much has been said in the news about how little President Trump has been able to pay in taxes in recent years, which he called smart during the last presidential election. Much of this was due to provisions that would have allowed him to use business losses in one year to offset income in other years. While most of us don’t have this luxury, there are a surprisingly large number of ways to generate tax-free retirement income:
1. Your employer’s retirement account. If your employer offers a 401 (k) or 403 (b) plan, in 2020 you can contribute up to $ 19,500 per year before tax or $ 26,000 if you turn 50 or over that year. It lowers your taxes now, but don’t you still have to pay income taxes when you take it out? Yes, but some or even most of this income may not be taxed.
First, each person can claim a minimum standard deduction of $ 12,400. For a married couple filing jointly, that’s $ 24,800 of tax-free income. If you itemize your deductions at retirement, your deductions (and therefore your non-taxable income) would be even higher.
If you need to withdraw more than $ 12,400 per person, the next $ 9,875 (or $ 19,750 if the spouses declare jointly) will only be taxed at 10% and the next income group up to $ 40,125 (or $ 80,250 for joint declarations) will be taxed at 12%. The point is, you can retire in the same tax bracket as when you worked, but find that almost all of your income is taxed at lower rates. On the other hand, your pre-tax contributions are grossed up and otherwise would have been taxed at your highest marginal rate. This is why it generally makes sense to defer taxable income until retirement.
If your employer offers a Roth option, it’s even easier to see the tax savings. You don’t get any tax relief now, but withdrawals from the Roth account are tax free after 5 years and 59 years. This can be a particularly good option if you can maximize it, if you plan to pay a higher tax rate in retirement, or if you plan to retire before you qualify for Medicare at age 65, because Tax-free withdrawals from a Roth account will not count against you in determining your eligibility for health insurance grants under the Affordable Care Act.
Finally, some pension plans allow you to contribute after tax. Income from these accounts is taxable when you withdraw them, but you can avoid this if your plan allows you to convert them to a Roth account so that they can grow to ultimately become tax exempt. If your plan doesn’t allow it, you can always convert the after-tax contributions into a Roth IRA after leaving the company.
2. Roth IRA. As long as you meet the income limits, you can also contribute up to $ 6,000 (or $ 7,000 if you turn 50 or older this year) to a Roth IRA. (If you go over the income limits, you can still use a “backdoor” approach to contribute.) As with the Roth 401 (k), all Roth IRA withdrawals become tax-exempt after you have held the account for at least 5 years old and you are over 59 years old.
3. Health savings account (HSA). If you are one of the growing number of employees on a high-deductible health care plan, you and your employer can also contribute up to $ 3,550 (or $ 7,100 if you have family coverage) to a health care account. health savings (HSA). in 2020, plus an additional $ 1,000 if you turn 55 or older this year. This can potentially give you the best of both worlds, as contributions are pre-tax and withdrawals are tax-free if used for qualifying health care expenses. Since you’re almost certain to have health costs in retirement, it’s a safe bet that you can count on this to generate tax-free income. (You can also use it for non-qualifying expenses without penalty after age 65, but withdrawals would be taxable in this case.)
4. Long-term capital gains. What about investments that are not in any of the above tax-sheltered accounts? There is good news for you here too. As long as your taxable income is less than $ 40,000 for a single person or $ 80,000 for a married couple filing jointly, your tax on long-term capital gains and eligible dividends would be zero. Just make sure you hold the investment for over a year before you sell it to take advantage of this lower rate. (If you keep the investment until your death, your heirs may receive an increase in the cost base, which means that if they decide to sell it, they could end up paying little or no tax on the gains in capital on your earning life.)
Plus, if you sell investments at a net loss, you can reduce your taxable income by up to $ 3,000 per year and carry over the rest of the losses indefinitely. This means that if you have $ 10,000 in losses from the current year and no other gains or losses for the next few years, you can reduce your taxable income by $ 3,000 this year, $ 3,000 next year, 3 000 $ the following year and the last $ 1. k the fourth year. (Think of this as similar to Trump’s use of his trade losses, but on a much smaller scale.) This is why it makes sense to have more volatile investments like individual stocks or emerging market funds in a taxable account. Just be aware that to take the losses, you cannot redeem the same or identical investment within 30 days before or after the sale.
5. Home equity. There are several ways to get tax-free income from your home. The first is simply to live there. Your home pays you income in the form of free rent, a concept called imputed rent. Fortunately, this “income” is tax free.
You can also take out a reverse mortgage on your home, which is exactly what it sounds like. Instead of paying your mortgage company, the mortgage company pays you and it’s not considered taxable income. You can also keep your house for as long as you live there. However, when you move out or die, the house will be used to pay off the mortgage company plus costs.
Finally, you can decide to free up part of the equity by reducing the workforce. As long as you have lived in the house as your primary residence for two of the past five years, you pay no capital gains tax on up to $ 250,000 of gain (or $ 500,000 for a married couple who make a joint declaration). Like other investments, the house can also be transferred to heirs with increased costs, which can reduce or eliminate any taxes on your lifetime earnings if the property is sold.
6. Investment property. Your home isn’t the only way real estate can lower your taxable income. If you own investment property, you can take depreciation deductions (typically over 27.5 years), as President Trump did. This will increase the capital gains tax when you sell the property, but you can pass it on to the heirs without them ever having to pay tax on the gain throughout your life.
7. Residual Charitable Trust. If you have a large number of taxable investments that you would like to generate income from and are inclined to charity, consider a charitable residual trust. It allows you to donate valued investments to the trust and benefit from a tax deduction equal to the total value of the investments (which can offset other taxable income). The trust can then sell the investments without capital gains tax and pay you income that may be more than what you would have received if you had to pay tax on the investments. The remainder would then be donated to the charities of your choice upon your death.
8. Social security. But what about your social security benefits? Don’t you have to pay tax on them? Not necessarily if your combined gross income is low enough, you may not have to pay taxes on your Social Security benefits. At most, only 85% of your social security income may be taxable.
When you add it all up, you can generate some tax-free retirement income. You don’t even have to be as “smart” as Donald Trump to do it. You just need to understand how to use the tax laws in your favor or consult a qualified financial professional who does.
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