Retirement is something you spend your entire life saving up for, and it should be a time that you are able to enjoy reduced income taxes now that you’re not working. The retirement savings strategies you choose will play a large role in what tax rate you end up in during retirement. There are really three main ways to save for retirement:
Pre-Tax: This strategy is very common, and includes Traditional IRA’s, 401(k)’s, etc. Money is deposited into the retirement account before any current taxes are taken out, and the money can grow over time. The theory here is that you have more money going into savings, because you didn’t have to pay tax on it, and that amount is left to grow until you take it out. When you withdrawal the money in retirement, the amount is taxable as income.
Tax-Deferred: This is a strategy where you set aside a portion of your after tax income into a retirement account. The earnings in the account grow tax-deferred, meaning that when you take out retirement income, taxes are due on the gain of the account, and not the original investment. This type of account is commonly seen in an annuity or nondeductible IRA.
Tax-Free: This is similar to the tax-deferred strategy. You contribute money to an account such as a Roth IRA on an after tax basis, and when you withdrawal money from that account in retirement, the principal and earnings are taxfree. It almost sounds too good to be true, which is why the government imposes strict contribution limits on several of these types of accounts.
AIf you’re looking to minimize your tax rate in retirement,the Tax-Free strategy would be the best choice, as you owe no income taxes on the money that you take out of those accounts. The money that was contributed to the account was already taxed, so it is not taxed again when you withdrawal it. Think of it as a farmer paying taxes on the seeds he plants instead of on the harvest he sows. The downside is that for many, their income is too high to contribute to a Roth IRA, or they are only able to contribute up to $5,500 per year.
Fortunately, insurance companies have stepped up to the plate to offer an additional tax-free income strategy through the use of new permanent indexed life insurance products. A permanent life insurance policy allows for an unlimited amount of contributions that will grow tax deferred. If structured properly, you can take income from the policy tax free. This is similar to a Roth IRA, but without the income and contribution restrictions. A permanent life insurance policy is also a critical estate planning tool that provides a guaranteed tax free death benefit to the beneficiary.
Although this is a very powerful strategy for minimizing your income taxes in retirement, it is crucial that you work with a qualified advisor to ensure that this strategy fits into your overall retirement plan. You will also want to make sure that you find an advisor that has experience with this type of planning, and the new insurance products that make these plans possible. If you would like more information on this strategy, please contact our office today at 708.481.4000 or at [email protected] to schedule a complimentary consultation.