Bridget Sullivan Mermel CFP(R) CPA
4 Types of Tax Free Retirement Income | Paying zero tax can be fun!
Paying zero tax in retirement is possible, but it doesn't generally happen by accident. In this episode we discuss major sources of tax free income that you might not have considered.
We'll talk about what to focus on when thinking about paying zero tax.
If you want to pay zero tax, you're not going to do it unless you focus on it!
This episode was inspired by @Jazzwealth Youtube video: https://youtu.be/B05OtAHXuJI
John's firm website: https://www.trinfin.com
For advisors around the US: https://www.acplanners.org/home
#retirementplanning #taxfreeretirement #financialplanning
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Bridget: Hey, John. People want to save tax in retirement, and they don't realize that there're four easy ways to have income that is tax free in retirement. And on this episode of Friend Talk Financial Planning, we're going to be going through those four ways. Hi, I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois.
John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. And before we dig into those four ways to create tax free income in retirement, I want to remind everybody to hit that subscribe button. When you subscribe, it helps us in the YouTube algorithms and helps other people find this information. And with that, Bridget, I love this topic about how to come up with tax free income. Everybody's worried about taxes, or at least it's on their mind. And I think that some people can really over focus on that. It's important, but there's a lot of ways you can have money tax free, aren't there?
Bridget: Yeah, there are. This episode is inspired by an episode by Jazz Wealth Managers, and they had their four ways, and we've got a little bit of overlap. I'll tell you what their four ways are at the end, and in our show notes, I will include the link to their video. But I wanted to talk about, as a tax professional, what the four ways are that I've seen over the years. The first way is your standard deduction.
Your standard deduction is basically income that you have that is not taxed. Your total taxes get reduced by your standard deduction at the very least. Sometimes people itemize if their itemized deductions are greater, but everybody gets at least the standard deduction. And if you are under 65, the standard deduction is $12,950 if you're single, and it’s $25,900 if you're a joint filer. Over 65 is $14,700 and $28,700 for married filing jointly. So that's a gimme; you just get this.
John: Think about that, though. I just want to pause for a second. I appreciate the detail because I always think, “What are those numbers again? It's like $12,000 if you're single, $25,000 if you're married, or somewhere in that ballpark, isn’t it.” But think about what that means. I've got to take money out of my retirement plans or wherever, and the first $12,000 is completely tax free no matter where it came from. The first $25,000, no matter where it comes from, is completely tax free. That's really significant. That's one of those things we kind of forget about. You get that money tax free no matter what.
Bridget: Exactly. Okay, so the next thing is Social Security. Let's talk about how Social Security is taxed. So Social Security is not taxable if your combined income is less than $25,000 if you're single, or $32,000 if you're married filing jointly. And the combined income is half of your Social Security benefits, your other adjusted gross income that are not Social Security benefits, and any non-taxable interest that you might have. This means that if you're careful about it, you can keep Social Security benefits not taxed.
John: Absolutely. People's reaction might be, “Well, jeez, how can I live on that?” We've got clients who are in a position where they can stay under that and pay no taxes at all. But one of the things that's easy to forget about is that when we talk about income from a tax standpoint, there's a real definition. And if I'm taking money out of the bank, let's say I've got CDs that are coming due, or I've got money market accounts, yes, I’m paying taxes on that little bit of interest, but when I take $50,000 out of my CD, let's say that I had earmarked to live on, that's not taxable income. So I can have maybe some pension, maybe Social Security coming in, and I can take money out of the bank, be under those limits and pay zero in taxes.
Bridget: Right. And if I had big expense that year but you happen to have a Roth IRA, you can take the money out of there, especially with the one-time expense, like you're giving money to your kids or you're buying a car or something. Otherwise, if you take it out of IRAs, et cetera, you might end up boosting your taxable income. So it's a great idea to take a look at that, too. Okay, so those are our first two. The next one is capital losses. If you have stocks in a taxable account, hopefully most of them have gone up.
And if you sell those and take the money out, then you must pay a tax on the sale of it, but you don't have to pay tax on the whole of it, just on the sale. If you don’t want to pay any tax at all, and you sell stocks that have gone down or stayed about the same, you don't pay tax on the capital loss. It actually benefits you. You can take up to $3,000 in a loss every year. To keep your income down and offset some of those other gains that you might have, this can be a really helpful option. And so that's, again, low hanging fruit. And in the business, we call that tax loss harvesting. So that's another stream of income that is not taxable.
John: Yeah, that's a great one. And you made me think of a situation where we helped somebody a few years ago as they were getting into retirement. We had a person who was selling their business, someone who had built up a successful business and was retiring in early 2020. And if you remember what happened later in 2020—the whole COVID thing. So they had some investments and their investments went down, so we did what you described, Bridget: tax lost harvesting. We took some money and were able to generate some losses on the tax return.
Because they sold their business, they had income, but then these losses from the investment side balanced this out, so we were able to wash out a bunch of their other income and pay zero taxes on some of the money that came from the sale of the business. And so, you think, “Well, jeez, maybe we don't have that much in our taxable accounts from an investment standpoint or other places.” But golly, if you can do some of that and reduce your capital gains even by taking $10,000 less than some of the gains, that’s meaningful tax-free income in your pocket. It's a great deal.
Bridget: Yeah, especially if you're in this situation where you're really trying to fine tune it to pay zero tax. For a lot of people, it takes a little bit of effort. And the fourth thing, which I've already mentioned briefly, is Roth distribution. So if you've got a Roth account, that's a great place to take some money out of as long as you've kept it in for the appropriate amount of time. As long as it's qualified, the Roth distributions are tax free too.
John: Yeah, that's great. You said something here that I just wanted to pull out. This takes some time to look at these things. It doesn't just happen. And as we talk about some of these, I know there's been some news recently about this tax loss harvesting and how the ultra-wealthy people use this and get big benefits from it. And this is neither here nor there for our purposes, but that same concept, that's what we're talking about on pretty much everybody's level. Regular people have an opportunity to save money and to be smart, but you can't just remain on autopilot. You've got to pay attention to those things, and you've got to pay attention to those things before the end of the year.
As we record this in the spring of 2023, it's too late to do very much for 2022 taxes. But during the year is when you can make these evaluations and try to make some decisions about this. And it's an ongoing process. Your situation is going to change, or at least may change every year, and you need to ask, “How can I take advantage of some of these things for a tax-free income in retirement?” It can be available to a lot of people, but you've got to pay attention and put in a little bit of time and effort with it.
Bridget: Yeah. And one thing you can do with your 2022 return is ask, “What is my total tax?” That’s the number that we care about. It's not if you owe money or you're getting money back. A lot of times people think that their balance due or their refund is their tax. But actually, what you want to focus on relentlessly, if you care about this topic, is your total tax. If you want your total tax to be zero, then look at your total tax and not at your refund or your tax due.
John: That's such a great point, Bridget. I'm glad you brought that up. I can't tell you the number of times I've talked with a new person, maybe a prospective client, and asked, “Well, what did you pay in taxes last year?” And their answer is, “Well, nothing. I got a refund.” Well, no, you paid taxes. It was withheld from checks, or you made estimated payments or those things. And that's what you're talking about. It's not “Did I get a refund?” or “Do I have to pay in at the end of the year?” Rather, it's “What's that line item on my tax return? What's that total tax number?” That's what we're trying to manage with things.
Bridget: Yeah. And so, the other things I wanted to just briefly mention at the end is what Jazz Wealth Managers also mentioned, because these are other places where you can get tax free income: life insurance proceeds; reverse mortgage proceeds; and sale of a principal residence (but it can't be over a certain amount, and you have to have lived there for a certain amount of time). With that, this is our real talk. Don't believe all the hype about how to save money on taxes. This is the real stuff. I'm Bridget Sullivan Mermel, and I've got a fee-only financial planning practice in Chicago, Illinois.
John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. And both Bridget and my firms are taking on new clients now, so we love people to reach out, but we're also members of the Alliance of Comprehensive Planners. And if you like what we talk about on our show and want to find a planner in your specific area, you can check out acplanners.org.
Bridget: And please subscribe.
At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.