How To Pay 0% Taxes In Retirement
- Mr. Organic
- Jun 26, 2019
- 4 min read
Updated: Oct 7, 2019
Tax Free Retirement
Do you know who your silent partner is in your tax-deferred retirement plan? More importantly, do you know what there share of your retirement will be? I'm speaking about the IRS.
If you have a 401(k), 403(b), traditional IRA, or any other tax-deferred vehicle its important you understand that the IRS is going to get a piece of your retirement pie. The questions to ask are how much? and how can I pay less?
The IRS has the ability to change the rules as needed. Luckily though we have a more clear understanding of what taxes will look like for at least the next 5 years (until 2026).
Before we get into detail, I want to first give credit to the book, The Power of Zero by David Mcknight. After reading this article if you truly feel compelled to hop on the tax-free retirement train, I would recommend purchasing his book.
For the context of this article, I'm going to provide a high level explanation that will get you started on the right track.
Why Is It MOST Important NOW and Until Jan 1, 2026? - "TAX SALE"
As discussed in my article: What You Must Know About The Tax Cut Job Act And What Happens After December 31st, 2025 Reversions, personal tax rates are set to revert to pre-2018 rates or the 2017 tax brackets after the Tax Cut Jobs Act provisions falls off on 12/31/2025.
What this means is we KNOW tax rates will increase in the future, and we are in what's called a, "tax sale."
We have seen an exponentially increasing national debt, solvency issues determined for social security by 2037, and an increasing need for money to fund systems like medicare and medicaid.
"As a result of changes to Social Security enacted in 1983, benefits are now expected to be payable in full on a timely basis until 2037, when the trust fund reserves are projected to become exhausted." See SSA.gov article
The fact of the matter here is that taxes should have never been cut. The natural progression of our taxes (with our current systems) should have increased to account for the tremendous amounts of government spending! (Not saying, I'm unhappy about it!)
Although, with that being said, from now and up to 2026 will be the most opportune time to take advantage of the tax sale. Lets get into how that will look.
Understating Provision Income and Social Security Taxes
The first goal of creating a tax free retirement is to understand how social security is taxed. Social security uses a formula known as provisional income to calculate how much of your benefit will be taxed.
Single Less than $25,000 provision income and Married less than $32,000 of provisional income will result in no taxes on your social secuirty benefit. Anything above these limits will result in 50% being taxable and up to a current max of 85%.
Provisional Income Calculation: Gross Income+%50 of your SS benefit+Municipal Bond Interest.
What If You Have a Pension Benefit?
In order to attain a zero tax bracket you must keep social security from being taxed. As you may notice if you have a guaranteed pension of $40,000/yr you will not able to avoid the first tax bracket because social security will always be taxable.
If you are in this situation, avoiding any other taxable income streams in retirement will be a imperative to maintaining ultimate control of your income. Next, we will review next how to create tax-free income streams.
Contributions to After-Tax Vehicles (Roth)
After you have 0% provisional income, you'll want to be sure to maintain the 0% bracket by not taking in any more taxable distributions above your standard deduction.
What this means it that the majority of your retirement assets should be positioned in tax-free areas. This involves making contributions to Roth IRA/Roth 401(k)s rather than to tax-deferred accounts. The limits are the same for traditional 401(k)s and traditional IRA as they are for Roth 401(k)s and Roth IRAs.
Roth Conversions
What if you already have a large amount saved in your current 401(k) plan? The goal here is called conversion, and you can make an unlimited amount of conversions!
The questions to ask is if the plan will allow a conversion while you are in service? If not, then you may need to look into rolling into an traditional IRA to then start the conversion process into a Roth IRA.
Also, can you afford to pay the taxes due on the conversion? Early withdrawal penalty (10%) does not apply to Roth conversions, but income taxes are due the year the conversion is made.
Keep in mind the TCJA personal income tax rates are scheduled to revert as of 12/31/2025. This provides 6 years worth of conversions that can be made at a potentially lower tax rate. For example, looking into a conversion strategy where you convert 1/6 of your total tax-deferred accounts at a time. Thus stretching that tax burden out over 6 years, and ideally not forcing you into a higher tax rate the years the conversions are made.
Please contact your trusted CPA when creating a conversion plan. They will guide you individually through exactly how much to convert each year for your specific level income and tax rate.
Time Is Limited! Act Now!
When the Tax Cut Jobs Act comes to an end in 2026 we may never again see tax rates at these low of levels again! Don't get stuck with the IRS as your silent partner. Trust me, they are in no way a good retirement companion!
Thank you for your time
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